“The risk is not Evergrande itself … This is metastasizing into other areas.”
We sit down with China expert Dr. Christopher Balding, a former professor at Peking University’s HSBC Business School and the Fulbright University Vietnam. We discuss the Evergrande debt crisis, the hidden inner workings of the Chinese economic and financial system, and Beijing’s increasing aggression toward Taiwan.
Jan Jekielek: Dr. Christopher Balding, such a pleasure to have you on American Thought Leaders.
Christopher Balding, PhD: Thank you for having me on.
Mr. Jekielek: Christopher, just recently, it’s been leaked that the Chinese regime has tested a hypersonic weapon, capable of delivering nuclear payload anywhere in the world. I don’t think it hit its mark exactly, but it shows a pretty incredible capability that, apparently, we didn’t know about in the West. I don’t know if that’s true or not.
At the same time, we have headlines like this one, “Washington Hears Echoes of the ’50s and Worries: Is this a Cold War with China?”
Mr. Balding: Well, it’s very difficult to look at the past decade under the rule of Xi Jinping—specifically, within the past two to four years—and not already know that we’re effectively in what I would term a Cold War 2.0. The intellectual difficulty a lot of people have in facing that is, they don’t necessarily want to face that again for understandable reasons.
It’s also the difficulty in accepting who your adversary is. If we were to look at China against various metrics of other countries like the Soviet Union or similar types of countries, China fits a lot of metrics that we would be looking at—state-sponsored depression, [and] expansionary objectives in different ways. It’s very difficult to understand how one arrives in 2021 not already accepting that as fact.
Mr. Jekielek: Okay. Let’s talk about the hypersonic weapon now. Do you think that U.S. intelligence, and the Western world were caught unawares as to the reality of the development of this, or as far along as it is?
Mr. Balding: I would be surprised if they were as surprised as the Financial Times report makes them out to be. I did not know that they were working on a hypersonic or, as China has now termed it—space vehicle, a space test. But China has clearly been working on similar types of vehicles, similar types of weapons delivery systems. They clearly have been working on that level of advanced technology.
Even if you don’t know that they’re working on that exact product, it is very reasonable to take, as a given, that they’re working on those general class and types of delivery systems that can avoid American defenses to deliver weapons to American, and other countries’ shores. So, I’m a little skeptical that we’re as surprised as we’re making it out to be.
Mr. Jekielek: Okay. Why the leak and why now?
Mr. Balding: It’s a little bit puzzling because it was clearly an authorized leak. This was clearly not some whistleblower. It’s what I would term an approved leak. Governments have approved leaks where they want to make it sound like a leak, but they get in a room and say, “Okay, which reporter do we want to leak it to? And who are we going to give them to talk to?”
It was clearly an approved leak. We don’t see anybody from the political side weighing in on this. This doesn’t seem to match what we know about what the Biden administration has talked about, or how they seem to be approaching China. So, I’m skeptical that it comes from the Biden administration or any of their political appointees.
It seems to come more from the defense or intelligence community. This leads to the distinct possibility that, if it was an authorized leak from the intelligence or department defense sector, there is probably a growing vision between what the intelligence law enforcement defense sector is seeing with regards to China and how they believe China should be treated, and how the political wonks in Washington, DC from the Biden administration would rather treat China.
Mr. Jekielek: It reminds me of something that I came across today in your Twitter feed. Elbridge Colby is saying, “Probably, my biggest urgent concern with Biden administration’s China strategy is that they seem to be confused about our ‘desire’ for this not to be a military conflict with the presumption that it will not be.” It references a piece that he’s talking about. Your commentary is that the administration might just not be ready to accept this kind of a reality.
Mr. Balding: What I meant by that was, I think there is this misconception in the United States and a lot of other countries that whatever we do is going to impact China. So, if we behave in a certain way, this will alter their course of behavior in some material way.
Whether or not we want to treat it as a Cold War, or as a conflict, doesn’t matter. It’s irrelevant. How does China view the situation? How are they behaving? They are clearly behaving, not just with the hypersonic weapon, but if you look at—across a range of other areas within defense and security—they view it as a Cold War-type of situation, and some type of impending conflict.
We could look at the South China Sea. We could look at what they’ve been saying and how they’ve been behaving with regards to Taiwan. We could look at Hong Kong. Clearly, that gives us an idea of how they are viewing the outside world. So, I think when Colby is saying that, we need to say … it doesn’t matter what we think. We need to understand how our counterparty is viewing the situation and react to that.
Mr. Jekielek: Let’s take Taiwan. What does Taiwan tell us? What do these dramatic increase in overflights … I’ve been looking at various types of this weaponized merchant marine activity off the coast. There’s a lot more activity. What is this telling us right now?
Mr. Balding: One of the things about Xi that is very clear is that he views himself almost with a sense of manifest destiny with regards to China. He is the individual that will restore China to its rightful place, sitting as the unrivaled power in the world. He is restoring China to its central place of power and control. That is his job.
He views himself very much, even though it’s not religiously accurate, almost as a messianic figure with regards to China. One of the things that he has talked frequently about is reuniting Taiwan and the mainland. He said repeatedly that, “If you don’t reunite with us peacefully, we will take you by force.”
This is another one of those situations where it doesn’t matter what Taiwan or the United States do. We can say it in the nicest possible language. There is a predetermined viewpoint on the Chinese side. There’s a predetermined course of action about where they want to go, and what the objective is. Either the rest of us get with that plan, or we are the enemy.
The increased activity has to do with Xi Jinping’s view about reuniting as part of restoring China to its rightful place as part of manifest destiny. If you view it in that sense, it makes a lot more sense.
Recently, there were reports from satellite pictures that there are three new bases being constructed right along the eastern seaboard facing Taiwan. The general that is in charge of the Eastern Theater recently took that post about 18 months ago. He was transferred from the Western Theater where he oversaw Xinjiang, Tibet and Indian-facing forces.
The reason that is important is that the person in charge facing Taiwan is probably a trusted loyalist, is the indication. This is a person that was preparing troops to do battle.
Now, we can say that they did battle poorly in India, but this does not indicate a movement that is, for lack of a better term, keeping the status quo. This does not indicate moving in somebody that is not highly trusted by Xi himself. So, these all point in the direction that there is increasing pressure on Taiwan.
I would expect that there’s a material probability of some type of conflict between China and Taiwan, plus or minus six months of November 2022, because that is when Xi is expected to be re-elected. If he is being re-elected for a third term—breaking the Communist Party mold of recent history—part of his reelection platform is to reunite Taiwan with the mainland. It’s not crazy to think that there will be some type of conflict with Taiwan within six months of his reelection.
Conflict can mean a variety of things. This doesn’t necessarily mean a “Private Ryan” type storming of the beaches. This can be a variety of approaches. But it is very fair to say that there is a 30% to 40% probability of some type of conflict with Taiwan within plus or minus six months of his reelection.
Mr. Jekielek: You’re talking about a lack of election or reelection. There’s been a lot of coverage in the past of him making himself dictator for life. What does this election really mean?
Mr. Balding: It’s funny, this is a big question. The reason that this is so important was after Mao, there was a major effort to limit leadership to two terms. What was so notable about it was that, even after Mao, even though he unofficially gave up power, everyone recognized him as the guy who ran everything even though he wasn’t the title holder.
More than Xi continuing, it is very important that Xi is breaking these norms. This has been a little puzzling to me, and I think there’s various reasons for it. We need to readjust how we’re seeing Xi and China. For many years, there was this overused proverb about, “Bide your time.”
We treated China as very conservative. I don’t mean this term politically, but conservative in that they would not make large or sudden movements—it was very “steady as she goes. We’re going to get there in some time.”
Under Xi, a lot of things … he’s very ambitious and revolutionary. I don’t mean this in the traditional communist sense of revolutionary, but revolutionary in the sense of willing to get rid of things that he didn’t like even if they went against party orthodoxy or international opinion, things like that.
Look at the South China Sea. He’s militarized the South China Sea. Look at Hong Kong, he said, “I’m taking Hong Kong.” The term that was thrown about was that agreement with UK is just an old piece of paper, doesn’t mean anything.
If we look at how he’s remaking the party and dealing with political enemies, he is not risk-averse as a leader. He is very willing to smash things that he thinks are no longer useful or serve his objectives. So, we need to get rid of this idea that the cost would be too high, the risk is too much.
I see little evidence that Xi, and China under Xi, [are] not willing to take those risks. I think they’re very willing to take those risks. They’re very willing to bear those initial costs. There might be some potential caveats, like if you start incurring large amounts of deaths, for instance, trying to invade Taiwan.
But the idea that he is bound or restricted, or conservative as a leader just doesn’t bear the weight of evidence over, even the past few years, much less his entire time in office.
Mr. Jekielek: I want to talk about the role of the Communist Party in Chinese society. You started to speak to this moments ago. But before we go there, tell me a little bit about your background because you have a unique perspective on China and its economy, and just how that evolved.
Mr. Balding: What makes my specific background and viewpoint of China different and unique is I never, at any point, set out to go to China, set out to learn about China. I learned about China just by living and being there. It really wasn’t until I lived in China that I even read books about China. I learned about China by making mistakes, doing the things you’re not supposed to and going, “Oh, shoot, I shouldn’t have done that.”
The first time we were ever in China was not because of me. My wife was an architect, [who], pre-2008 Olympics, was building some of those big homes and buildings in Beijing and a couple [of] other cities around China. This was, by Chinese standards, a pretty open period.
But even then, unknowingly, we were surveilled and scoped out by security services of some kind. I did not ask for identification, but it became very apparent who was trying to ingratiate themselves with us.
Later, I moved back with a family at this time to take a job at Peking University. Again, I started learning, “Oh, well, this is why things are done a certain way. This is how conversations take place.” I made the mistakes that a lot of people probably wouldn’t make. So, you get exposed and taught about how society operates, how conversations take place.
One of the times I’m most proud of, and I lived in China for about five, six years at this point, there was a meeting at work. I don’t even remember what the meeting was about, but in a lot of Chinese conversations, nobody will actually talk about what’s being talked about. These conversations are rich with subtext.
Whatever this meeting was about, I was like, “Oh, I get what’s going on. This is really the conversation taking place.” I went to a colleague, dear friend, and I asked them, “Is this really what happened in this meeting? I believe this is the subtext and what the conversation was really about.”
They looked at me and said, “You now speak perfect Chinese without actually speaking a word of Chinese.” I felt that all of a sudden, by being able to interpret body language and subtext, you get a much better idea for how a lot of these things that are so beneath the surface and not readily apparent, unless you’ve experienced it, become apparent. That really formed a lot of how I understand China.
Mr. Jekielek: But you chose to leave at some point.
Mr. Balding: I went there after the global financial crisis in 2009. At the time, with my wife, we said that we would stay as long as long as the job was still a good job. Realistically, I thought I’d probably be there three, four years, and I started having children. Those three, four years turned into nine years in China and I really enjoyed China.
My three children went to private Chinese schools. They got the Chinese method of how you learn Chinese. Just write the words over and over again. When I hear Chinese parents talk about it, I understand that more than the American schooling system, which I’m now being exposed to, and I’m like, “This is so strange.”
But we left after nine years because I got fired for complaining about censorship. At the time, there were some journals in the UK that had censored some journal articles. I raised this issue publicly. Peking University decided that it was time to end our mutual relationship.
I started picking up in 2014, 2015, that China was really changing. When I was looking for a job in 2017, I started calling friends in Hong Kong, “Hey, is it… should I try and get something in Hong Kong?” All of the friends and contacts I had in Hong Kong universities, banks, other places, said, “Chris, do not come to Hong Kong. It is going to be a bad scene soon.”
It’s one of those things similar to the hypersonic glide. I was a little surprised at the way things unfolded in Hong Kong. But everybody I talked to when I was leaving, indicated how bad things were. It wasn’t an entire surprise.
After leaving China for professional and personal reasons, I made my way to Vietnam, which was a case study in contrast—even for a communist authoritarian government—just how different it was, and how they’ve responded to similar histories. I was in Vietnam for two years, which I thoroughly enjoyed.
Mr. Jekielek: And then, you felt that you needed to, not too long ago, make it here. Why is that?
Mr. Balding: I was advised by a number of individuals that it was probably not going to be safe for me in Vietnam to continue publishing the research that I was doing on China. There are a number of known cases where China, let’s say, disappears or makes accidents happen in China.
There was a recent case where multiple individuals of senior Vietnamese military leadership were arrested for espionage for China. Even though Vietnam and China are bitter enemies in many ways, there’s also risks if you’re going to be criticizing China, even in Vietnam. I came back last year in 2020 to the United States.
Mr. Jekielek: Was there some moment where you decide to—because you’re talking about your run-ins with state security, you’re always open minded, wanting to learn—where you decided, I’m ready to say things which are clearly not going to work with the subtext that you’re describing.
Mr. Balding: When I first started saying things about China, this was probably 2012-2013. I was reading what people in New York City and Washington, DC were saying about China. I was like, “This is just not based in reality. This is not what is going on in the ground here.”
This is one of my very common frustrations with a lot of what is written about China, coming from Washington, DC and New York City. These people have just not spent either any time in China or Vietnam. Or if they have, they’ve spent a weekend at the Four Seasons meeting with senior executives from major companies or the senior officials from the Chinese government.
Having been to some of those nice hotels in Beijing and Shanghai, as well as other South East Asian countries, it doesn’t matter where you are because a Four Seasons is still a Four Seasons. Ritz-Carlton is still a Ritz-Carlton. You’re not gaining much information or knowledge about the country, and it was not reflecting what I was living on the ground in China. That’s when I decided to start writing about what I was seeing and witnessing in China.
Mr. Jekielek: I remember noticing some of that, and I was thinking, “Wow, this guy is actually doing this? How long is this going to last?”
Mr. Balding: I always had the mentality, if they ever came to me and said, “Okay, it’s time to go.”—it’s time to go. My personal or professional identities were never bound up in maintaining that access.
I was talking to someone who had to leave China, and is not welcome back. They said when you deal with China, you have to accept the risk that you will lose those relationships, that you will lose that access. But the price is that, if you’re going to maintain that, you have to say, accept or do things that will eat your conscience.
I entered into it, saying, “Hey, if they don’t like something I write, and they want me to leave, okay, there it is. No big deal. I’ve had fun.” I think I started writing about China in 2012-2013. I left in 2018. To China’s credit, they actually let me stay for quite a while, in relative terms. To my boss’s credit, the dean at my school, I’m pretty sure he went to bat for me a number of times to keep me there. I probably would have been outed sooner if not for him.
Mr. Jekielek: What would be an example of something that you were seeing on the ground as a reality? The most stark example that you can think of that you saw, but New York and Washington, DC were seeing a completely different picture.
Mr. Balding: One of the things that pops to mind was one of the first papers I did, and this was probably 2012, 2013, 2014. I forget the exact timeline, but inflation was definitely running significantly higher. At the time, there was a lot of suspicion that maybe Chinese data wasn’t entirely accurate, but people were going to let it slide.
I was looking around at price hikes in China that were significantly in excess of the 1% to 2% inflation that they were reporting. I was able to say, “Guys, this just isn’t what you’re seeing on the ground.”
Just to give you an example of inflation, the prices by Chinese standards, I was in the top 1%. But the average price was probably far in excess of anything, real estate price wise, that you would see in Manhattan, San Francisco, Silicon Valley, you name it.
When they were talking about how great the economy was, and consumer spending, they were taking a lot of these figures as given. To be able to go out at times, take pictures of prices and say, “Guys, this doesn’t make any sense.” Providing credibility-on-the-ground service. I do think it is harder, with a lot of the journalists that have been kicked out that are unable to go out and do that, and being pursued and surveilled the way they are today.
Mr. Jekielek: Fascinating. Tell me about the data in China. Can we trust it? How does it work?
Mr. Balding: There are a couple of answers to that. I’m going to tell a couple of anecdotes. I was meeting with somebody who was a government official in China. This was before the crackdowns really started taking place. I was told a story that somebody else that they knew, another government official in a local branch of the Statistics Bureau, got busted for selling the real data. They were selling the real data to people.
This was at a time when the corruption crackdown was really just starting to take off. I asked this individual, “Well, did they get busted for corruption or national security?” They said, “Oh, national security, we can’t have that information out in public.”
Just to hear the confirmation that there was real data, and fake data was quite eye opening from an official. They know very clearly the targets that they have to hit. There is enormous pressure to censor upwards. We always think of censorship as going downwards to the people, the state media and things like that. But there is also enormous censorship upwards of how information gets conveyed upwards.
Nobody goes and tells their boss, “Hey, we had a bad year this year.” That is the first thing to keep in mind that yes, there are absolutely different sets of books. Chinese authorities famously treat them as if there’s two different sets of books.
However, that has become much harder for China, to fabricate data to such a degree that it doesn’t match with other data. Let’s assume you have a coal mining province or a town, or a province that has lots of steel. Well, how do you make steel? You burn a lot of coal. What happens when you burn a lot of coal? You have lots of air pollution.
So, if we can measure that the air is very clean this year, what likely didn’t happen? We likely didn’t burn a lot of coal. If it’s a coal province or a steel province, and you’re not burning coal, that likely means that economic activity was down. What you’re trying to do is to reconcile things that are much harder to fake. Two things that are easy to fake.
If those two numbers come close, and we’re not looking for exact matches, but as long as they’re generally moving in the same direction of similar magnitudes, we say, “Okay, close enough to borrow from the old supermodel phrase, ‘I don’t get out of bed for less than 5%.'”
What you’re really trying to do is match data that the government publishes, which is very easy to manipulate, to data that is very difficult to manipulate. Air, lights, things like that. We can measure air by satellites. We can measure lights by satellites. There’s different things, but you’re trying to reconcile very manipulable data to very difficult-to-manipulate data. That’s actually become a lot harder for China.
When I hear foreigners say, “Oh, Chinese data is actually pretty accurate.”, I say, “Chinese don’t believe Chinese data.” The reason is every firm in China has gotten into the data business. Simple real estate firms realize, “Wow, I’m just leasing apartments. I actually have tons of data on how many empty apartments in my province there are.”
That’s valuable data to people that are studying the real estate industry, going, how many empty apartments are there? How often are people moving? If people are moving, they probably need transportation services. If people are moving there into new apartments, they’re going to be buying couches, they’re going to be buying refrigerators, things like that.
You see this with lots of firms. You see it with real estate. You see it with shopping malls. You see it with UnionPay and Alipay, and all these guys. If there’s more transactions every month on Alipay, we probably can say, yes, consumer spending is going up. There’s all these ways that people are inventing. What this is telling us is that the Chinese don’t believe Chinese data.
Mr. Jekielek: It’s almost like a data black market.
Mr. Balding: Yes. Not only is there this legal market of data. There is a very thriving black market of data in China in different ways, whether it’s if you know somebody at the National Bureau of Statistics that will sell you the real data. Chinese markets are widely known for abnormal price movements before big announcements, whether it’s a quarterly earnings report, the grain reserves, things like that.
It’s widely known that these markets in China move in ways they shouldn’t if there was a data blackout. So, there’s absolutely a thriving black market for data in China.
Mr. Jekielek: We have to talk about Evergrande here. This is something that’s on everyone’s mind. People are asking, “Is this potential default? Is it something that could take down the global economic system?” I’ve even seen that postulated.
Then, there are other people that are saying the exact opposite, “This is not going to have any impact. The Communist Party’s got their handle on this.” Where do you land on this?
Mr. Balding: There’s a couple of issues with Evergrande. First of all, can the Chinese Communist Party control Evergrande as a situation? Absolutely. No question. They can.
Mr. Jekielek: Three hundred billion dollars, apparently, right?
Mr. Balding: Yes, absolutely. In economic terms, that’s not a negligible part of GDP, but that’s a very small percentage. There’s all kinds of things that they could do. They’ve done similar things with HNA, a bankrupt conglomerate. They absolutely can just make this problem go away very easily.
There are a couple of issues, though, with Evergrande that make it very unique. The size—yes, it’s bigger than others. That’s not the dominant issue. The real issues with Evergrande are this—I don’t think anybody, even in China, really knows what their liabilities and operations are. They have hundreds and thousands of suppliers.
One of their suppliers, an aluminum company, has announced that they’re bankrupt. That’s their biggest aluminum supplier for, I think, a specialized aluminum product. They have literally hundreds of thousands of Chinese citizens expecting delivery of an apartment.
Mr. Jekielek: Some of those have been blown up, apparently.
Mr. Balding: Yes, absolutely. Then, you have all the suppliers that they have written IOU’s to. That’s assuming everything that they have said about their current state of operations and debt levels is completely accurate, which we all know is not the case.
The first thing you have to ask is, what is their actual state of operations? There are probably people trying to figure that out right now as we speak, burning the midnight oil in China. To a degree of fairness, anytime you have a mega bankruptcy like this, the first thing the accountants will do is go in and try to figure out what is actually there. What are the actual debts?
Inevitably in every case, even in good ones, you will find the material amounts of liabilities that you didn’t know were there. Not to mention behemoths like Evergrande, where I’m sure that there are going to be enormous amounts that they didn’t know were there.
The risk by Evergrande itself, they could go in, shut it down, problem solved. The problem you really have to the Chinese economy is—and this is where the censoring upwards and censoring downwards is really difficult for China—the risk is not Evergrande itself.
The risk is, and we’re already seeing this, where China is really running on a very dangerous tightrope, you’re seeing Chinese citizens lose faith in real estate. Real estate transactions in China have plummeted. In Shenzhen, they were down to … a city larger than New York, you had less than 2000 resale transactions. You probably do that just in a day easily.
If I’m just ballparking off the top of my head, the entire metro area of Shenzhen, that’s probably, roughly 5 million units. That means they’re doing 2000-unit resale transactions a month. Think about how many hundreds of years it would take to turn over that real estate stock.
The reason that matters is, with the sky-high real estate prices, if people start to lose trust in real estate, they’re not going to buy. If they’re not going to buy real estate, the prices are going to fall. We’ve already seen announced reports where Chinese authorities are just saying you can’t lower the price.
If you look at the real estate sector outside of Evergrande, you’ve already seen real estate firms default. Others issue warnings that they’re on the verge of default because banks are now scared to lend to any real estate firms—even for good projects, if there are good projects.
We’ve seen the suppliers get caught up, not to mention Evergrande’s aluminum supplier. There are other suppliers that are getting … So, if you take Evergrande in isolation, they could snap their fingers and solve that problem because they don’t know what’s there.
Because they don’t have a game plan to solve this, this is metastasizing into other sectors—into the retail sector where people are buying apartments. They’re saying, “You know what? Now is probably not a good time to buy.” That’s where the real risk is.
People have faith in a bank because they can go there and get their money. If people lose faith in the bank, even if the bank still has a good balance sheet, the bank is going to collapse because everybody wants to go get their money.
So, the real issue is, can they manage this so that people don’t lose faith in other parts of the Chinese economy? Whether it’s real estate, that aluminum supplier, the cement company, or that bank. We’ve heard rumors about Ping An Bank, which is located in Shenzhen, facing real difficulties. That’s where the real risk is, not in Evergrande by itself.
Mr. Jekielek: That’s fascinating. Speaking of numbers and data, the official GDP numbers are out. I guess it’s down from 7.9 to 4.9. What does that actually mean for us, for investors, or for the Chinese for that matter?
Mr. Balding: Coming out of 2020, China declared that they were going to really push hard to make up for lost time. 2020 was not quite a lost year, but it was almost a lost year with corona. Their credit numbers in early 2021 were just astronomical.
What we saw in the first couple quarters of this year was GDP growth really accelerated, and it was targeted heavily on construction, real estate, other infrastructure, things like that. That is where most of the GDP growth came from.
However, as they saw inflation starting to rise, which is an enormous fear of the CCP, they really pulled back on credit. They started pulling back on credit in, say, the spring—the middle of Q2 in 2021, which would be April, May, June.
In China, what we say is that there’s typically about a six-month lag from the time they’re pushing or restraining credit till it shows up in GDP numbers and in real activity. If they were pushing credit in the latter part of 2020 and early 2021, it makes sense that there would be large amounts of activity in Q1 and Q2. And if they’re pulling those numbers back in Q2, it makes sense that we would see that.
Where we’ve seen the drop off in economic activity is directly in construction. Whether it’s train construction, we’ve seen cancellation of projects, or real estate, and we’ve definitely seen cancellation of projects. That’s really where the drop off in GDP is.
Mr. Jekielek: It doesn’t sound like this is an issue, in your mind.
Mr. Balding: In many ways, no, it’s not all that surprising. I don’t think it has a lot to do with the current worries about Evergrande because they started tapping the brakes on credit growth earlier this year.
Mr. Jekielek: Is there a threat with respect to the global economy, or the U.S. economy and China right now?
Mr. Balding: I think there are a number of specific issues. For real estate, I do think there is a risk to the global economy writ large. China is simply a wildly overbuilt country. And it is a wildly indebted country because of that real estate. Chinese households are more indebted than almost any developed country household, and definitely, more than any country even close to its level of income.
The Chinese household is more indebted than the U.S. household, Russia or Mexico, which it compares pretty closely to per capita income. That’s going to provide an enormous restraint in the future going forward to consumption, to additional real estate purchases, things like that. That’s going to spill over into whether it’s luxury goods, whether it’s international mobility, or international education—a lot of the things that China has become known for over the years.
You simply can’t carry forward in economy with the levels of depth that we’re seeing. One thing they say is, “Well, the United States has high levels of debt. Japan has high levels of debt. China has high levels of debt. So, it really shouldn’t be that big a deal.” But that really overlooks a very key issue.
Debt servicing … how much it costs to pay back that debt as a percentage of Japanese national income. Because, depending on the day and what traders are doing, Japan has almost zero cost to carry that debt because their interest rates are zero. Even in a quarter or 50 basis points for a lot of companies that they might have to pay, that’s a very low cost to the national economy.
The official rate in China to the 10-year government bond is 3%. So, if you think about leverage, you’re already taking up 15% of GDP by the time you count non-government debt and those other issues, and how much it costs to service that. You’re talking about 15% of GDP to service that. Where, in Japan, it costs 1% of GDP. It’s very different when we’re saying, “Well, these other countries have high debt levels.” China, for a number of reasons, is a very different case.
Mr. Jekielek: Do tell more.
Mr. Balding: An economist that I admire greatly, Michael Pettis, who has lived in Beijing for many years, raises the issue that Chinese GDP is what he termed, “not an indicator of output, but rather an input.” U.S. statisticians will say, “Well, Americans did this, this quarter. They produce these many widgets. We produce these many hamburgers. And so, this is what our GDP is.”
Chinese GDP is an input. Just as a company will have a sales target, we need to increase our sales this year, 10% or something like that. Chinese bureaucrats will sit down and say, “Well, we need to increase our government revenue at the provincial level, 8% this year, and we need to increase GDP as much.”
The easiest way to do that is through infrastructure spending. It creates steel jobs, cement jobs, and labor jobs to do that. It creates service jobs for architects. That’s a very tangible way that the government can generate GDP.
Research and development for technology are very difficult things to do. It’s a very unpredictable thing to do. Whereas, if I give you money to build a bridge, I see that cement is getting produced, and that bridge is going up. That results in a flow to GDP. That has been the Chinese business model to achieve elevated growth rates for the past, approaching 15 years.
I remember this was the first year I was in China, coming out of the global financial crisis, they needed to make sure that they were cushioned from that downturn. So, they actually increased spending.
At one point the first year I was there, one of the first articles I read in the local Shenzhen Daily, I was like, “This doesn’t seem right.” I went and actually checked the data, because I’m like, “This is crazy.” New loans in 2009, we’re increasing at four times the rate of the previous year. Not 4%, higher. Not 40%, higher—four times greater than the previous year. That’s an astronomical number.
What happened in subsequent years is they said, “Jeez, unless we want significantly lower growth rates, we have to keep increasing credit growth significantly higher.” One of the issues that you may have heard talked about is this issue of Chinese deleveraging.
Well, just to put it in perspective. This year, a number that they call total social financing, which is a metric of all debt outstanding, is up more than 10% this year. Nominal growth is probably going to come in with the first quarter—I would guess probably around 7%. So, it’s still growing.
The debt growth rate is still growing far in excess of nominal GDP, which is increasing the amount of outstanding debt faster than how fast they can actually pay it back. That is the fundamental concern—that they’re not able to generate GDP growth without major increases of debt, foreign excess of GDP growth rate. Those numbers simply cannot continue.
Mr. Jekielek: This is a very interesting question. There has to be some inflection point here.
Mr. Balding: If you wanted to say that there was a real storm, you could make a very good argument that there is a real storm surrounding and in the Chinese economy. You’ve got Evergrande. You’ve got the debt that is out there. You’ve got potentially falling real estate prices.
I did some back-of-the-envelope math, real estate prices have already fallen enough that the household wealth effect has dropped, probably, equal to about 7% of GDP this year. So, that’s a pretty significant number. You could very well make a case, there would be a financial crisis issue.
For many years, I have taken a viewpoint that, at some point, those numbers will have to reverse. They simply cannot go on like that forever. It will have to stop. I have taken the stance that it is a political question more than an economic or financial question.
I was discussing this with somebody who knows much more about the Chinese economy than I do. We were discussing the possibility of a financial crisis. They looked at me, and said, “No, there’s not going to be a financial crisis.” I said, “Well, why is that?” They said, “In authoritarian states, if there is a financial crisis, it does not end well for leadership.”
And this is the existential question for China, just as Xi believes himself to be a man of manifest destiny. One of the other aspects to his belief system is that he does not want to repeat the mistakes of the Soviet Union. He does not want to preside over the collapse of China. There is no check too big that he will not write at the end of the day. There is no bailout too large that he would be unwilling to bail out.
Chinese leadership can talk about wanting to introduce, “well, you knew what you were buying. The government didn’t guarantee that wealth product. Government doesn’t guarantee real estate.” But what happens when real estate prices in China drop 15%, and all of a sudden people are rioting, protesting because they can’t sell their apartments, they can’t make their mortgage payments. He will change his mind very, very quickly. He’s not going to be the leader that tolerates people on the streets protesting a fallen real estate.
If you look at the data, one of the most common reasons for mass events in China, their word for protests or riots, is something to do with real estate. That absolutely takes us to the point of, “Do they want to bail it out?” At the end of the day, Xi doesn’t want to go into exile in the Maldives. He wants to live out his days as the Emperor in China. And how do you do that? You bail out companies in China, rather than tolerate dissent.
Mr. Jekielek: A number of guests on this show have said that the CCP is incredibly dependent on U.S. dollars. As you’re describing this whole situation in this accelerating debt, I can’t help but think back to that, and this interest to pump more money into the Chinese economy by some of these giant funds, for example.
Mr. Balding: Yes. They will talk about the internationalization of the RMB and other things like that, but it is still an entirely dollar-dependent economy. The RMB is on par with North Korean won.
You can’t escape that. Outside of China, it is not widely used. If it is, when you look at the payment statistics about RMB, what you’re typically talking about is something akin to a Chinese subsidiary or something like that. There are really no international transactions that move across borders that are processed in RMB.
The Chinese economy is entirely dependent on dollars, and it has to keep that flow going. There are enormous leakages in how Chinese get money and their wealth out of China. There’s an entire cottage industry in capital control evasions, money laundering, and other things like that. It comes in a variety of different ways. It fluctuates, depending on interest rates and how tense politics are.
One of the very common ways to move goods, and they were doing a lot of this at different points when I was in China, they would literally sell goods into Hong Kong at one price. That truck would turn right back around and resell the goods back to China at a different price, just so the net effect would be moving money to Hong Kong. That was the entire purpose of the transaction, to move money to Hong Kong.
A lot of companies in China will be able to get money out of China to fund an R&D lab or something like that in a foreign country. Now, that R&D lab may be a four-bedroom house in suburban Los Angeles or Palo Alto, but that gets labeled in the foreign exchange transaction book as an R&D lab in Palo Alto.
I knew an individual in China that worked as a special assistant to the CEO of a not insignificant company. One part of his job was to buy real estate for the owner in different major cities—luxury real estate—structure it in ways so that it would pass Chinese currency exchange regulators.
For the past couple of years, we’ve seen China declaring these enormous surpluses. But during that time, foreign exchange reserves have been flat. Mathematically, if your surpluses are going up and up, why do your reserves or let’s say your savings account, just stay flat? Doesn’t make any sense. There are enormous leakages.
One of the questions about China is, are their foreign exchange reserves really trustworthy? If China is so ebullient about their level of dollars, if they’re so happy and, “Hey, everything’s fine. Dollars are fine. Foreign exchange reserves are fine. Currency reserves are fine.”, why would they let foreigners invest in the stock market and in government debt? Doesn’t make a lot of sense, does it?
One of the very reasonable ways to interpret their desire to get foreign money in is that they need those extra dollars. As an American, what is so deeply problematic about those flows is, not only are they going to a clearly adversarial state, but most of those funds are going in the form of what they call passive indexing.
There are companies that are included in an index, the top 500 companies on the stock market. Every dollar that goes in gets divided equally between every company. The problem is that it doesn’t strip out Chinese military companies, Chinese weapons companies, Chinese down the line, Chinese companies that are involved in Xinjiang. All of these types of companies, he just throws the money into the stock market pot, for lack of a better term.
What you’ve seen is a lot of everyday Americans—a lot of this is done through pension funds, 401(k)s—so that if you’re a teacher ,,, The U.S. military retirement fund only recently took these options off the table. The U.S. military 401(k) and pension funds were investing in Chinese military companies by sending money through index funds to China. We are actually helping fund a very real enemy.
Mr. Jekielek: I want to get back to the question of the role of the Chinese Communist Party because everything we’re discussing here has to do with some sort of central authority making profound decisions affecting society and, of course, well beyond Chinese society. Tell me about that.
Mr. Balding: One thing as an American is that it’s very difficult to understand just how central the CCP is to everything in China at all levels of life.You go into an apartment building, and there will be the party representative.
You go into a school, there will be the party representative. Every organization of any size you can possibly think of, there will be a party representative. It’s not like, oh, this is just somebody who shows up in most any organization. They are effectively the power that be, so to speak.
The CEO might make the business decisions, but the party representative who is frequently the CEO in large companies will also determine what the workers do, and the songs that the worker sings and these types of things. The party’s influence, to an everyday American, is not something that is even comprehensible.
If you’re an American and you choose to ignore politics, nobody really cares. You don’t have a party representative determining your HOA. You don’t have a party representative telling the school board, “Actually, this is what you need to do.” and the school board follows it. It is really difficult for an everyday American to understand the centrality and importance of the CCP in everyday Chinese life.
Chairman Xi holds many titles, but the only title that really matters is that he is the chairman of the Chinese Communist Party. He is the head of state of China. But the title that matters in China is not the head of state. He is the chairman of the CCP. Everybody, even the head of state, is answerable to the Chinese Communist Party. That is something that is lost even on many Americans. It took me a while to understand just how central that role was.
Mr. Jekielek: The CCP is supreme at every level of society, bar none. You mentioned Xinjiang, and the party secretary being everywhere. There’s a whole other layer now, a technological layer, where it’s become a surveillance society with the social credit system. And it’s not even just within China that this technology is applied, but now it’s being exported.
Mr. Balding: Another thing a lot of Americans don’t really understand is the degree of surveillance and intrusion into the privacy of citizens that the Chinese government has. There are databases where we can literally watch Chinese citizens go about their daily business, and follow somebody throughout their day—from the time that they wake up in the morning till the time they go to bed.
There will be one camera for every two Chinese citizens. From the time you leave your apartment, you will be surveilled—from who you interact with, in many cases, what you are saying. The information you are texting to people is all there for people to look at. There are no restraints on the Chinese government to surveil you, to control you.
They do get marked, absolutely, for sensitive content, thought problems, the degree of severity, all of these types of issues. This occurs for how China surveils international individuals. We’ve heard about the government hack of OPM. But in today’s society, as individuals put things on the internet, this is why China gathers all kinds of data from social media platforms.
This is why, even though I have a very active social media account, I do not put any personal information about the names or pictures of myself. People know my name, but I do not put my picture on social media. I do not put information about my family, pictures, names, other things like that on social media.
I can tell you, the Chinese government highlights individuals that have security clearance. They use these platforms to recruit individuals, to highlight individuals that need targeting. This feeds into their information gathering about what businesses have information we need to obtain. So, that could be turned over to a hacker.
There’s this concept in China, what we call civil-military fusion, where the government works hand in hand with business. In the United States, there are businesses in parts of Microsoft or AWS, who provide cloud services to the government, may bid on a government contract. Google and those other companies actively fight and are actually very proud of their efforts to fight government intrusion into their users’ data.
Now, we can debate how much they do, and they absolutely have to respond to lawful requests for warrants, and things like that, in what we call a warrant management system. We’ve never found any evidence in Chinese databases of warrant management systems, where there are controls over data that block who has access to information unless you input the necessary … It is simply there for government officials to access whenever they feel like it.
As an American, very similar to the CCP, it’s very difficult for an outsider to understand just how much control you are under, just how much censorship. They have scanners. They have facial recognition that can tell if a child is in class, if they’re tired, if they’re paying attention.
These are the levels of control that they’re exercising, that we, as Americans—not just with regards to China, though definitely with China—we should be concerned about with the level of government control. Because you see the technological tools available here in the United States, and something we should be aware of, not just with China, but also with the United States.
Mr. Jekielek: There’s a lot of questions about how best to deal with China, all the way from decoupling the economy entirely, to … Of course, there’s a contingent that’s pushing engagement as well. I think this is playing out in the government as well, these varied perspectives. What would you suggest—given the economic realities—for a good direction for the U.S. government, in terms of dealing with the CCP.
Mr. Balding: We’ve clearly seen that China is not a reliable trading partner. We see this in how they treat other countries, in how they have treated U.S. firms, and in how they treat their citizens. We see this in their aspirational targeting of countries like Taiwan, and in what they’ve done with Hong Kong.
We clearly need to accept some of the costs, either impose costs on China or accept some of the costs to change behavior. We should decouple to the extent that we should work with companies or other countries to shift trade away from China. That could be Mexico, Vietnam, India. That could be European countries, or African countries.
A lot of the manufacturing that we’re talking about, especially the lowest of the low wage, garments, textiles, things of that nature, could easily be moved to other countries like Africa, Latin America. I think that would be very advantageous. That’s going to take American leadership in different ways from the government, as well as the business sector. Electronics is another area, where it’s very important to move away.
Somebody that I know well put it this way, “Chris, I’ve seen enough of this, that if there is something China can hack, they have.” I’m beginning to think that that’s probably not a strong enough statement because China has clearly shown time and again, that they will absolutely, whether it’s hacking, or devices that are implanted with malware, all the way through to withholding key inputs, they absolutely have no qualms about doing that.
Those are not people that we should be forming the cornerstone of an American trading relationship with. I think you’re starting to see a change in mentality to … When we’re talking about decoupling, there was this idea that they have these supply chains in China that are just so ingrained now, they can’t be changed.
Apple has now started an iPhone manufacturing plant in India. It is churning out lots of iPhones that are being flown all over the world. Clearly, the iPhone is a little bit of a unique product in different ways to make that happen so rapidly, but it’s clearly dawning on people.
Yes, this can be done. We don’t need to be manufacturing in China. In fact, if you look at the longer-term outlook in 2021, we probably want to be in the Indian market. It’s growing more rapidly. It has much better demographics. We want to be in that market.
The political battle taking place is this administration has not recognized yet the costs associated with being willing to impose or accept those costs to change behavior. The administration needs to look seriously at how to impose costs.
Secretary Raimondo from the Commerce Department talked about, we want to engage with China. I’m not against engagement with China. It needs to be on our terms. And it needs to be with costs imposed for lack of adherence to the rules and laws of trade and business. I don’t think that’s something, however, that we’ve seen this administration have the appetite to do.
Whether it’s in the trade sector or another, they seem distinctly unwilling to impose serious costs or show American leadership to say, “We’re going to be willing to take policy directions to engage with allies to move that trade away from China, so that we are building up other allies and reducing our risk and exposure to China.”
Mr. Jekielek: Well, Dr. Christopher Balding, it’s such a pleasure to have you on the show.
Mr. Balding: Thank you very much for having me on.
This interview has been edited for clarity and brevity.
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