Red Flags for China

Published on
October 3rd, 2018
Topic
Geopolitics, China, Debt
Duration
31 minutes
Asset class
Equities, Bonds/Rates/Credit

Red Flags for China

The Expert View ·
Featuring George Magnus

Published on: October 3rd, 2018 • Duration: 31 minutes • Asset Class: Equities, Bonds/Rates/Credit • Topic: Geopolitics, China, Debt

George Magnus, former Chief Economist at UBS and author of the recently published “Red Flags: Why Xi’s China Is in Jeopardy,” discusses the panoply of political and economic risks arrayed against China and its leader Xi Jinping: Ballooning debt, political instability, a demographic time-bomb, and the ever-looming threat of declining growth and a weakening currency. Filmed on September 27th, 2018 in London.

Comments

  • GT
    Garry T.
    18 December 2018 @ 10:54
    Remembering Japan in 1989, it was all going great until it wasn't. It was hubris and overreach, and piles of debt. It had achieved an economic miracle, but it was mostly an economic bubble. Perhaps an exact comparison is unfair, but in some regards current developments give pause to think. Several fed flags.....and even some new ones since this talk was recorded. Thanks to Professor Magnus (George) for his insightful analysis of the current complex situation in China. I hope you can have him back for a follow up talk as developments warrant.
  • F
    Floyd .
    11 October 2018 @ 22:46
    just listened to Mike Howell before this, i would say that these two men have very different views of China,but that is a good thing . Frankly I found George's background comments more helpful in formulating an opinion of China. Probably one of the more practical,useful and understandable economic analyse that I have ever heard from an economist,no offense. His comparison to the Soviet Union was very insightful. Having him back to periodically update us on how the four challenges are unfolding would be valuable.
  • DY
    Damian Y.
    11 October 2018 @ 06:17
    Great interview, I love listening to English Boffins. This is a definition of fascism: a political philosophy, movement, or regime that exalts nation and often race above the individual and that stands for a centralized autocratic government headed by a dictatorial leader, severe economic and social regimentation, and forcible suppression of opposition. Sounds like China? This is a definition of mercantilism from wiki:Mercantilism is a national economic policy that is designed to maximize the exports of a nation. Mercantilism was dominant in modernized parts of Europe from the 16th to the 18th centuries before falling into decline, although some commentators argue that it is still practiced in the economies of industrializing countries in the form of economic interventionism. It promotes government regulation of a nation's economy for the purpose of augmenting state power at the expense of rival national powers. Mercantilism includes a national economic policy aimed at accumulating monetary reserves through a positive balance of trade, especially of finished goods. Historically, such policies frequently led to war and also motivated colonial expansion. Sounds like China? Steve Forbes has a very good book called Money:How the Destruction of the Dollar Threatens the Global Economy, that talks about mercantilism in modern economies. It's well worth the read. China doesn't have a rule of law like we have in the west, as a lot of these western companies are now finding out when their technology is being stolen by China. This is becoming a very big problem. With a Debt to GDP of 330% at the end of 2017, China has a lot of very big problems ahead of it. It will be interesting to see how all this plays out.
    • DR
      David R.
      12 October 2018 @ 00:27
      "With a Debt to GDP of 330% at the end of 2017, China has a lot of very big problems". That's one of most misleading and therefore inaccurate statements bantered about out there, according to HF legend Ray Dalio. Look up his interview and what he's written about it in 2018. I'll believe a world-beating HF manager with money on the line (and winning big) 100 times out of 100 when it comes to such assertions. Likewise for Singapore's misleadingly high debt-to-GDP, whose assets (including many liquid investments) in fact far outweigh its alleged "high debt" (thus their extremely low tax rate and zero sales tax, investment tax, inheritance tax, corporate tax etc). In fact the country with the huge debt and problems is USA (among other social democracies), with its $200-trillion of off balance sheet debt on top of its official debt load of $22-trillion (excluding all subfederal gov't debt!), at 1168% of GDP, and most of it unproductive debt for social entitlements and some counterproductive war toys that cost a fortune and have bled the nation into technical bankruptcy dozens of times over. Many western countries are in a similar hopeless condition. It's why they're now funding academics to formulate and stoke credibility for the debt jubilee "solution".
  • MB
    Matthias B.
    8 October 2018 @ 17:49
    grateful. apologies.
  • MB
    Matthias B.
    8 October 2018 @ 17:48
    I am impressed and very greatful for all the feedback by the viewers. I thought that the arguments and salient points were the best in a long time in a feedback section. Truly appreciate it, as valuable as the interview itself. tks!
  • DR
    David R.
    7 October 2018 @ 15:27
    For a counter viewpoint, check out this week's MacroVoices episode with Louis Gave of Gavekal Research, a European firm which also actually has boots on the ground staffing large research offices in Beijing and Hong Kong. They're not retail; they only deal with institutional clients for private investment funds into Asia and (expensive) research. Bottom line is they're very bullish on the Chinese economy and bearish on the US economy after the near-term, also with the belief the US will lose its reserve currency status (sooner than most expect) and the USD will collapse, causing a big economic reckoning for the US and a plunge in the US standard of living. Check it out.
    • AP
      A P.
      7 October 2018 @ 21:54
      The main point of Gavekal is that there is no need for China to go back to building a massive current account surplus as this would keep their $ dependency well alive, so this is something of the past. Which is why they sought to (1) Stabilize their currency vs other major Asian currencies (SGD, HKD, THB, etc) (done) as they seek to anchor the RMB as the currency of Asia (2) Finish their Russia Oil pipelines with agreements to pay in RMB while giving the option to settle in gold for the Russian (done)(3) Make sure your currency is stable in relation to gold (done) (4) Create an oil futures market in RMB that is well functionning after just a few months a operations (done). And cherry on the cake, this means that the Chinese have no interest in going full force retaliation on trade (though taxing a few $60bn American goods still is a good move to show that you are not totally unprepared/victimized) and just need to save time for dust to settle and strengthen this newly earned position (but in the meantime a less-present US in the region is also something that they really want, in-fine). Magnus for me is neutral in his views - though struggling with the idea of China running current account deficits for the long run - while Lacalle is bearish as he focuses on massive structural issues in terms of how things 'should be' (and as Magnus points out, no-one has any clue of what the right debt level should be - you just cannot say 'it's just too high' just to sound dramatic) and with barely any mentioning of geopolitics/geoeconomics (his point about China's "toxic" is very well spotted though). These are 3 very complementary views that I very much enjoyed. Looking at the speed at which the oil futures market has been developing in only 6 months, I am not just that saying 'only 1% of global trade is settling in global trade' (Magnus' view) will hold for a very long time.
    • DR
      David R.
      11 October 2018 @ 00:53
      No, I think as an institutional client I see that their main focus and my main interest is their investment thesis as I spelled out above, not theoretical economics which has little to do with successful investing or portfolio construction. By the way, Ray Dalio correctly communicates that China's net debt to GDP is much less that the US, not worse, another false narrative often parroted by the US financial media which is very low on investigative prowess and very high on repeating whatever they hear. Much like the false narrative of the "strong dollar" which has been anything but strong for two years (and getting weaker again this week, with the weakness likely to accelerate going forward).
  • HJ
    Harry J.
    7 October 2018 @ 01:03
    Buy the way long term economic forecasts seem to be as reliable as weather forecasts.
  • HJ
    Harry J.
    7 October 2018 @ 01:00
    It’s amazing to me that we have sooo many experts on an at best opaque data.
  • WM
    William M.
    6 October 2018 @ 17:47
    With this week's sharp spike up in interest rates, China wouldn't have to sell much of their t-bonds to rattle financial markets everywhere. Sure it hurts them too (at least in the short term)...but maybe it's better than their other options right now....and would have much quicker results...
    • JM
      Juanfranco M.
      7 October 2018 @ 07:56
      And the professor kind of disregarded the effect on th USA if the Chinese would use the option of selling their treasuries. That would be horrible for thr dollar and the american economy who is going to buy the 1 trillion in treasures the Fed? Aren,t they tightening?
    • DS
      David S.
      9 October 2018 @ 05:57
      I do not think that China want to rattle the T-bond market as they are making a lot of money on them and gold with the RMB devaluation. China will, however, sell T-bonds and gold if it is in their interest. Maybe it is not good to push them too much. DLS
  • DR
    David R.
    4 October 2018 @ 21:56
    Following up on the demographics, this is a familiar theme in the West, but I see a very different perspective in the East. Remembering that China has had a big overpopulation problem (like Africa is hurtling towards). So today, although China has three-quarters of a billion people who enter retirement age in 20-30 years, China also has 650-million people aged 29 or less. That's a LOT of youth. DOUBLE the **entire** population of the US, and surpassed only by India in terms of absolute number of young people. So I'm not sure the Chinese demographic story is such a dire one. Not with so many youth in absolute numbers. And elderly Asians don't really expect entitlements from the state/gov't comparable to the west, as in Asian culture it is the responsibility of children to care for parents, not the state/gov't. Anything from gov't is seen as a "bonus" and probably temporary - and Asian think in CYCLES not LINEARLY like westerners... a KEY point. Also, is it reasonable to compare China with Japan, because Japan is more "developed" (more social programs more entrenched), and furthermore the total population of Japan is only 9% of the population of mainland China (even excluding Hong Kong, Macao and Taiwan) and more urban. So different situations.
    • MP
      Máté P.
      4 October 2018 @ 23:11
      Proportions are more important than absolute numbers imo. As you said, those 650million ppl of younger generations will have to take care of their parents. That's still a healthcare expense (doesn't matter if it's for your parents or for yourself), that leaves your most productive generation with a burden to carry, slows down the emergence of the middle class and as such the country's transition towards a more consumption driven economy.
    • DR
      David R.
      4 October 2018 @ 23:45
      Mate,... right.
  • DR
    David R.
    4 October 2018 @ 21:38
    IMHO, Chinese President-for-life Xi is the top red flag for China because through his big central planning and renewed "socialism with Chinese characteristics" governing style, he is reversing the tremendous progress initiated by Deng Xaoping, a reformer who believed in free markets to do the best he could to turn China from a failed socialist state towards an entrepreneurial, market-driven, increasingly capitalist juggernaut (like the US used to be before the onset of its chronic decline under the creeping socialism that Deng rejected having experienced firsthand for decades how economically devastating state socialism truly is - just like Venezuelans). Deng was inspired by the magnificance he witnessed in the rich, booming, free market uber-capitalist "Chinese" city-states of Hong Kong and Singapore (witness the movie Crazy Rich Asians haha), and Deng sought to plant the seeds of that success back in China. Alas, along came Xi.
  • DS
    David S.
    4 October 2018 @ 19:55
    Excellent long-term look at China. Chinese trade practices are real and do need to be addressed and remedied. China, however, does have a lot of non-tariff barriers to use when the US tariffs are increased. It does not need to go tit for tat. It is easy to provoke anger in the US administration and the China will use this to further its position in cultivating political friendships in the rest of the world - Europe, Russia, Korea, etc. The Renminbi will fall with the Chinese government stepping in every so often to control shorts. Chinese $US and gold reserves are increasing in value daily vis-a-vis the Renminbi. This US tariff war may be good domestic US politics, but it looks like a Pyrrhic victory to me as it is being played now. DLS
  • ly
    lena y.
    4 October 2018 @ 19:10
    Unfortunately it’s hard to understand the Chinese model. I doubt the capitalism in the western culture can full apply to Chinese culture! China has five thousands years of dictatorship which is like in grained in the culture. As Ray Dalio says family comes before individual in china. Ones sacrifice is an honor ! With such a huge population it is hard to govern with democracy when citizens are not ready! We’ve seen it in India!
    • DR
      David R.
      4 October 2018 @ 20:34
      The other cultural consideration is that Asians expect ZERO handouts and entitlements from government. The gov't is your enemy, like a Don Fanucci gangster, NOT someone that'll ever help or look after you. That's family. So what will be interesting is, when the many trillions worth of promises made in the West are wholly defaulted on (mathematical certitude), how violently do the masses react in the West, compared to in the East where no such entitlement expectation exists culturally? The answer is obvious I think. Stoicism in the East but massive violent civil unrest in the West unlike anything in human history.
  • YB
    Yuriy B.
    4 October 2018 @ 04:55
    Obviously Magnus is a brilliant guy. But he fails to acknowledge one way that an aging China differs from an aging U.S.: in China, it is culturally normal for the elderly to die peacefully rather than be subjected to endless invasive, expensive life-prolonging hospitalizations and procedures. An aging China is unlikely to bankrupt itself primarily from healthcare obligations. China obviously has other financial problems besides this one. But it is western-centric to view China's demography problem solely in Americo-European terms.
    • AP
      A P.
      4 October 2018 @ 07:29
      The main point, which he mentions briefly, is that an aging population is a drag on the economy as more and more people leave the labor force and consume much less. Magnus only mentioned the US/EU pension systems for comparison's sake.
    • DR
      David R.
      4 October 2018 @ 20:46
      Europe is aging just as quickly. The difference is that Europe, under the force of Merkel, brought in millions of MENA migrants, which improved the demographics, but are overwhelmingly illiterate & unskilled and in many cases criminals, rapists, terrorists even. Millions of them scattered about western Europe sucking up the generous social benefits (welfare, freebies, etc) and being a huge drain on the economy rather than anything beneficial---- much WORSE situation than had they kept the status quo of an aging population. Maybe not politically correct to say so in the excessively PC-obsessed USA, but wholly acceptable to say in Asia and increasingly acceptable to discuss in Europe (witness the election results across Europe and Merkel's political repositioning). And looky here, now the Afd has strongly taken 2nd place in German polling and is pressing to be #1, hmm.
  • DI
    Dabangg I.
    4 October 2018 @ 02:11
    that horrible loud music never fails to annoy. least normalize it with the speakers base volume.
    • SD
      Stephen D. | Contributor
      4 October 2018 @ 03:31
      Do you think it was specially selected as particularly approriate for a man in his 70's who is an Associate at the China Centre at Oxford University? It's more than just annoying, which it is, it's stupidly inappropraite to the man and the subject.
    • my
      markettaker y.
      12 October 2018 @ 00:26
      +1 on the annoying music. Milton....
  • DV
    Daniel V.
    4 October 2018 @ 01:59
    Please have Mr. Magnus have a regular and periodic update on his views.
    • JL
      James L.
      4 October 2018 @ 03:40
      second that
  • RA
    Robert A.
    3 October 2018 @ 22:05
    I always enjoy both the substance and the articulation of this Gentleman’s presentations. Thanks Milton for this timely refresher on some of China’s challenges.
  • T~
    Tshort63 ~.
    3 October 2018 @ 21:39
    Superb. Nice to have a cogent view with plenty of context and data to support longer-term views. Better than the bubble vision sound bites.
  • TB
    Tim B.
    3 October 2018 @ 16:55
    Excellent piece. In regards to the tit-for-tat trade war, there is another option that the Chinese have. There could be “grassroots campaign” against western companies, especially high profile ones. Apple comes to mind as an obvious target. Action could take the form of boycotts and “enhanced government regulation.” Furthermore, if Apple has important suppliers in China, those could come under various pressures as well. Like the other strategies mentioned by Mr. Magnus, this line of attack has it’s drawbacks, but this is a card that China has played before and could again.
    • DR
      David R.
      4 October 2018 @ 21:09
      The trump card (lol) that China holds is its Rare Earth Elements, as China controls about 90% of the global supply, without which life quickly reverts to the style of the 18th century. No computers, no networks, no manufacturing, no electricity, no pumped water, a dead-in-the-water nonfunctional military before long (except for men with spears riding horseback), etc. The pentagon is well aware of this and scared sheet-less. US attempts to mine REM in Alaska have failed. It takes a dozen years or more to mine any REM, at best. A large REM discovery under the ocean hundreds of miles from Japan has been effectdively destroyed by a rogue North Korean nuclear "test" missile, leaving the area fatally radioactive for centuries. There's some REM in Africa (as well as 90% of the world's cobalt in Congo, the key mineral for rechargeable batteries and Electric vehicles), but Africa including Congo is mostly owned & controlled by China now - with nearly a hundred million Chinese already living there to ensure it stays under Chinese control. How does anyone counter that? (Answer: you can't)
    • WM
      Will M.
      5 October 2018 @ 17:51
      Agree with David R. Rare Earths are a potential big trouble area for the west. Doesn't seem to be many options outside China. I am watch ARAFURA Resources in Australia (ARAFF). They may have a very viable source about to come into production in a couple of years. Stock is cheap currently. I do not currently own any but might splash out a bit on a gamble for the rare earth potential rise rises..
  • JG
    John G.
    3 October 2018 @ 15:34
    A well-constructed thesis and forecast, in my opinion. I can't see how the debt and demographics won't slow growth in China. In comparison, I would like to see another interview with Simon Hunt who, in May of this year, was extremely bullish on China (12% annual growth) after the government restructures its shadow banking system and provides more lending to the tier 3-5 cities and rural areas.
    • DR
      David R.
      5 October 2018 @ 13:59
      I think the bullish case is based on strong income growth from lower-middle to upper middle for about 1-billion people (the remaining half-billiion or so already comfortably wealth or filthy rich already). The lower 1-billion people will buy stuff we take for granted, as their situation improves (like it is), pushing fast growth. Plus they have much higher productivity and higher adoption of technology (notably mobile) than in the West, and the infrastructure in China already topnotch is becoming world-best. US infrastructure is frankly embarrassing. Infrastructure is essential for future growth gains. Last but not least, they are pushing to become global leaders in tech (and already have in a few fields), which will help growth. I expect US to retain tech leadership in some fields like biotech while Asia will reign supreme in others, like in robotics and quantum computing where it already leads and probably next in AI and maybe fintech (to wit, Martin "The Forecaster" Armstrong's compelling thesis that China will be the global capital of finance after 2030).
  • JB
    Jack B.
    3 October 2018 @ 09:42
    Excellent summary!