RUSSELL CLARK: If everyone else could devalue, why can't China devalue? The reason why is because they've chosen not to. If you're changing the trade rules, we're going to change the currency rules. We'll go home on Friday. And over the weekend, the Chinese go, all right, that's it, we're going to rip the band aid off. And we come in and the renminbi is at nine. RAOUL PAL: When we're looking at something like a recession, we need a global perspective. Now, with so much programming in these two weeks, it's difficult for me to be everywhere at one time. So, I need somebody to go and do my interviews in London and Roger is the obvious fit for me. Roger and I've known each other for 20-odd years. He knows how I think, and he knows how I'm thinking about this recession. So, I wanted him to go and interview Russell Clark.

Now, Russell is one of the best-known fund managers in London. He's an extraordinary brain. And he's one of the people we really love on Real Vision, because he has a different perspective. He always has something unique. And see, Russell has this theory about China that really is quite out there. And his viewpoint is that it all starts with a Chinese devaluation of the RMB. And then leads into broader knock-on effects. It's a brave call, and something I really wanted Rogers to dig in with Russell about to get to the bottom of and see how that might affect some of this recession watch view that I've got. ROGER HIRST: Russell, welcome back again to Real Vision. Great to have you on.

RUSSELL CLARK: Thanks for having me.

ROGER HIRST: We're talking about China within the context of recession, because we're in recession week. Now, you've been looking at China for a long time, you've been looking at a slowdown in China for a long time. Could you put it in context, how long that slowdown has been going on? How deep it is compared to the headline data that no one trusts? And what you're looking at to generate that view on China's current position, it's effectively drove momentum.

RUSSELL CLARK: So, China's always a slightly tricky market, because the data and also a lot of the financial markets and laws are sophisticated as they are in particularly in the US. And so, you still have to tease out a little bit. So, to give context to the China story of the moment, if you go back to, I think, the '14, '15, '16 periods where fears of China were at a peak, what you saw was being up into slowdown, was you started to see problems in its corporate debt market. A lot of that was driven by the slowdown in commodities, so lower oil prices, lower steel prices, lower iron ore price and lower coal prices.

And just to remind people, in the aftermath of the financial crisis, China has gone into wealth management product, P2P lending boom. And a lot of these products were based on getting high yields out of like coal mines and iron ore and steel factories. So, as you started to see margins in that industry collapse, credit problems start to emerge in China. And they started to become self-feeding, which then create pressure on the currency, which then create deflationary pressure through the whole global system.

And ultimately, that was what got priced in the early '15 and '16. And then the Chinese authorities responded through two things. One is a forcibly reduced loan capacity in all industries, and then do the fiscal push. And so, what this did was that for the survivors, it created huge cash flow, huge profitability, and cauterize the corporate bond problem. So, you knew who was going to be the loser and who's going to be the winner. And so, you could stack uncertainty back into investing and the way we went.

Now, what is unusual in China at the moment is, if you look at markets like the auto market, there's a clear sign of a slowdown. And it's been slowing for a while. If you look at the import-export dollar out of markets like Korea, they're exposed to China, have slowed down massively down near the 15% to 20% year on year. The weird thing is, if you then look at things like Chinese steel production have actually accelerated to be up 10% year on year. And so, what you can see is the external environment, probably driven by the tariffs and trade barriers being erected out of the Trump administration has certainly slowed growth in China and had the same problem.

The same time, the Chinese authorities have responded to that for domestic stimulation. So, you see iron ore, steel productions at very high levels, and also housing prices have been very, very strong. The problem you've got with that, when you really cut into it, is what you're seeing in the Chinese steel market and what you're seeing globally, is that all of the profits from increasing steel production is going directly to a strained mining corporations. So, the margin on cash production in China, even though they've gone to record levels, has actually dropped to zero, virtually. And so, the stimulus of the Chinese authorities are applying to the economy to counteract slowing trade, it's actually not feeding through to the domestic economy.

As likewise, as we've property markets, this has always been an issue for me, I think we saw it in London back in '15-'16 period, and you start to see in Hong Kong is that you can keep getting house prices up to create a wealth effect. But at a certain point, it gets to this point where people go, well, actually, I have to save so much money to buy a house, I'm not going to save. It almost becomes irrespective. I'm related to their wealth. And in fact, for people who do want to buy a house have to save so much money, and interest rates are so low, it just becomes a pipe train, and actually becomes a negative for the economy.

So, I think that's high house prices is definitely a driver of like Brexit votes, for example, I think it's a driver of the unrest we're seeing in Hong Kong at the moment. When you remove the prospect of homeownership from so many young people has negative, I think we're really at that point in China, where the traditional stimulus that they've used for the last 10 to 15 years doesn't work. And so, then creates all other issues, which we're starting to see come to the fore.

ROGER HIRST: And how much of that change do you think is the liquidity injections, the use of credit 14%, 15% of GDP annually pretty much for a long time? And how much of this slowdown is, is a slowdown that's out of their control. This slowdown, it's intentional, they've always talked about moving away from the growth of any cost model to something which is more domestic, may be forced into that because of other external issues? But some of these slowdowns that we're seeing, could that be attributed to a change in direction and a redirection of the internal liquidity away from just a growth model towards maybe shoring up some of these excesses within business? And therefore, what we're seeing here is not so much necessarily a catastrophic slowdown in China, but a slowdown in China and a redirection in China has a massive impact on the rest of the world that got reliance on this one models of pre-2018.

RUSSELL CLARK: So, what's interesting to China, and it's something we've seen replicated across the entire world is when growth is good, what we've seen is central banks or governments try and win us off this QE model. Well, so unlimited credit to try and get growth going, same was in China, they crack down on P2P lending, they try and reduce steel production to rebalance. Because if you want to be a modern economy, your steel industry should be shrinking, not growing. Does that make sense? I know, it's always hard for people who worked in coal mines or steel factories, but actually, modern economies are not built on the back of endless steel production growth.

And the problem is, because we have so much credit around that whenever any government or central bank has looked to move away from stimulation, you always see a big slowdown and lower asset prices about six months to a year later. They realize excess to steel production was bad, that excess of house speculations is bad and P2P lending was bad. So, they did crack down P2P lending. But when you look at like debt to GDP, which is beginning to flatline for a couple years, it started to accelerate up again.

And this basically being the model of growth for last 15 to 20 years is that growth, it costs regardless a long term consequences. And the model of that is the Japanese experience just doesn't work. There are differences in different countries, but just doesn't work, in my experience.

ROGER HIRST: With China, it's been interesting, because we- I don't know, how many China bears has been over the time. And it's always a feeling that they have this access in pretty much every area, but I guess to the things they've been able to- not so much control, they're always worried about is obviously the FX reserves, as long as that's stable, which has been at 3 trillion for a while. And inflation is the other one in a semi-closed economy because of stuffing in liquidity. You're worried about inflation, but there's been no inflation.

So, can't China, in a way, continue to transition if we're going to call it that? Stuffing loads of liquidity as long as they keep one eye on that inflation figure, as long as inflation is relatively static, and they're not pushing the yields down so low that it causes more money to want to get out of the country? Are they going to confound us? And so, it goes back to scenario where China within the global system is a big worry, because it's changing. And we're feeling that. You can see it in Germany. You can see it in Taiwan.

But China itself might manage its way through this. What is it that's in there that's- what worries you is the stuff that you can see in some of the data? Or was it some of the externalities because you've seen a few currency pairs, things like that, and were going there's clearly some problems here?

RUSSELL CLARK: Now, the numbers of lead indicators on China back in the '14-'15 period got very, very weak. And the market was still believing in the China story. Market still believe in the China story, evaporated through late '15, early '16. And then the Chinese changed policy, a number of indicators turned positive again. Now, what's happened this year, probably around when Raoul got very, very bearish was you start to see strange movements in the currency markets, which is always what I like to keep a close eye on.

So, you've had a lot of very strange moves. So, this time, with more interesting, obvious ones, for probably for most reviewers, is the Australian dollar has continued to be weak, even as iron ore prices have gone to five-year highs. So, Australia is now running like the largest current account surplus ever, which historically is a very bullish signal. And yet the Aussie dollar continues to be weak. I think in a way because it's a lead indicator on what the renminbi is doing.

And when you look into the guts of like iron ore and the steel industry, what you're seeing is almost the Aussie dollar's falling steel prices, which are generally falling more than iron ore prices are coming up. Which makes sense to me, because the market's looking through the current strength in iron ore and going, you know what, actually, it's not real. It's a supply issue. But it's not being driven by demand. When something is not driven by demand, it's very hard to be bullish, because supply issues get resolved.

ROGER HIRST: And people, I think, at the beginning of the year, where everyone's looked at that massive injection and reflation to the big story in January, everyone's, oh, China is doing it again. And as you said, the Aussie dollar didn't really react to it not like 2016, mining stocks didn't. And if you look at things like copper, sitting on this quite a technical level, a big neckline looks like it's going to break down. So, the market's believe in copper not iron ore. And so, what was it that was wrong about the reflation? So, if you haven't looked that liquidity and position for reductive 2016, and we didn't get anything close to it?

RUSSELL CLARK: Yeah, look, like I said, if you're in classic emerging markets- so Turkey is a good example. Like if you push through the liquidity, and people don't believe in the economy, liquidity just goes out the other side. So, just talking currency depreciation, and which creates more inflation, but it's deflationary for your trade [inaudible] if that makes sense. Even like Turkey has been putting liquidity into the system, it doesn't actually benefit anyone, just currency weakness.

And in a way, I think that's what- if you look at what the Aussie dollar is doing and so the other currencies are tightly traded with the renminbi which is Korean won and Taiwan dollar, both suddenly have been weakening. Again, the signal that the money is just flowing out, which makes sense, because you have a very different attitude towards trade out of US, much more than to use tariffs, you had some very, very high interesting trade policy out of Japan, with Korea, I'm not sure if has been widely followed. But the Japanese banned the export of some semiconductor materials to Korea as part of like a trade war. They did just after the G20. So, when people went talking about that it could be a quite significant issue. Who knows?

But you've got a lot of very- so, the currencies are saying deflation. And the equities are saying inflation. And the bond market is saying deflation. And so, this the dichotomy you have is that which one of those is true.

ROGER HIRST: And people- and you talked about currencies, then one of the things that Raoul talks about is the second level on renminbi, and whether China will or won't- not obviously devalue, but actually let its currency go because that has enormous implications. The Asian dollar index is basically renminbi, but the Hong Kong dollar looks like it could break down. It's related to emerging market equities. So, in some ways, the big arbiter for the global economy or potentially the touch point for something quite naughty happening in the global economy could be the Chinese go, okay, actually, we are going to let the renminbi go. What's your view because you've got some strong views on the renminbi and what they should be doing?

RUSSELL CLARK: Well, looking at, I think, since the financial crisis, China has been the rock around which everything's being built, because they've been willing to keep their exchange rate very strong, and do huge amounts of fiscal stimulus and push up property prices to act as like a consumption, source of consumption for the world. And their currency was actually very cheap in 2008, and then as a euro and then the yen fell against them and then emerging market currencies fell against the dollar. And by definition, renminbi and Hong Kong has gotten very, very expensive.

And the question you have to ask yourself is if you look at how the rich world works, everyone has devalued at some point. The yen went from 80 to 125, got from 160 down to one. This time, it's gone from 210 to 126, 127. Korean won did a very similar thing in '08. It went from 800 to 1600. And so, you got this question of if everyone else can devalue, why can't China devalue? And the reason why is because they've chosen not to, that's been their policy, they want to have a strong stable currency.

The problem is, is that, look, one of the things I try and do is when I travel, I try get an idea of where is cheap and where is expensive, it always more makes more sense to short or be bearish the currency that's expensive than the currency that's cheap. With China, so if you get like the two most expensive places these days for me is one is Hong Kong. The other one's probably San Francisco. And so, both of those are reflective of where the industries or the economies of both those places are.

And so, yeah, I would look to see, at some point, China says, well, look, if you're changing the trade rules, we're going to change the currency rules. The only issue with that is with something like the Trump administration never [inaudible] all those guys, if China suddenly devalues, I can't help but feel the Trump administration goes fine, tariffs to 50% or something like that. But then you get a cascading bear market. So, we're in a very tricky point.

So, like I said, the weird classic macro indicators are diverging radically from what equities are doing. And that does happen sometimes. Usually, the macro indicators are right. The best example I can think of is commodities back in '08. So, long time ago for most people, but commodities went parabolic in the first half of '08, as we're getting into recession.

ROGER HIRST: And August was the peak in oil, I think, Lehman happened a month and a half later.

RUSSELL CLARK: Yeah. And then suddenly, and it was very weird, didn't make a lot of sense. And then suddenly, it broke in way. And that's typically how markets work. They force everyone into an asset at exactly the wrong time. And then liquidity just disappears, and you are stuck in it. So, the weirdest thing about '08 is for the first half of '08, there are a lot of emerging market. So, hedge funds are up 20%, 10%, 15% especially the Russia type guys, ends up being down 50 billion a year as reality kicked in.

ROGER HIRST: And for China, wouldn't they think that- it seems that what they've actually been doing is that they've let the currency drift lower with the tariffs. So, in 2018, tariffs going, currency moved towards seven, offset the tariffs. And then again, this time around a little bit less powerful a move, wouldn't be a thought for them maybe more sensible to say like, what we're going to do is we'll let our currency go in response to aggression, rather than be the aggressive because nowadays, they're importing more and more oil. So, they're becoming more of an importer than an exporter necessarily. So, stable currency will be good for that because it reduces or doesn't- it keeps a lid on inflation, which is another big bugbears.

And eventually, in a normal world, they probably want to open up the capital accounts and get foreign direct investment to buy the bonds and therefore, fund the deficits US-style, isn't it that they would probably like to keep the stability so they will keep the internal stability, but by doing that, it creates this externality which we're seeing in Australia, in Germany? Where the real fear here is that they've changed the direction of their liquidity, they've changed the direction of their growth, and the world hasn't really caught on to what they're doing yet. And they're still thinking it's going to be- or we were thinking until a few months ago that it was going to be China saves the day in the PBOC provides