China slows down

0:05Pushkin. It's never a good sign when your country stops publishing bad economic data. But this is in fact what is happening in China. They just today stopped publishing the very high youth unemployment rate on the same day that the central bank did an emergency, unexpected rate cut. This is obviously not good news. And it's also just new. People are used to thinking of China as this fast-growing behemoth. It's taken over the world. It's surpassing the U.S. But that's not happening. China is slowing down. Today on the show, we ask, how bad is it? This is Unhedged, the markets and finance show from the Financial Times and Pushkin.

0:45I am reporter Ethan Wu here in the New York studio, joined by economic sputtering expert, Robin Wigglesworth. Hey, Ethan, how's it going? Robin is an avid watcher of economy struggling of all kinds, including China, but not just China. No, no. I mean, some people like to go to watch football games. Some people do some pottery or carpentry. I love sovereign debt crises, countries hitting a bad patch. It's my hobby, as it were. Yes. Well, then you are the perfect guest to talk about the sputtering the Chinese are experiencing. And, you know, Robin, I thought we could do this by talking about three different indicators that kind of capture the Chinese slowdown, which some are even calling a recession, whether or not that's the right terminology.

1:26And the three are inflation, exports and property sales. And I think each of these sort of speak to a different chunk of the Chinese economy that are going wrong for reasons of their own. And then together, they kind of paint this picture of the Chinese economic machine stalling. So just to start with inflation, the consumer price index for July in China came in at negative 0.3 % compared to the last year. Prices are falling. It's entered deflationary territory. And before we get into kind of what's going on with inflation, maybe we should talk about why deflation is a bad thing from first principles.

2:03Yeah, it's a good idea because for a lot of people, deflation sounds like an unambiguously good thing. Prices are falling. You know, I can afford to buy more stuff. The problem is that deflation is usually a symptom of something very bad, which is that people are getting poorer. You can't afford to pay so much that people have to cut their prices. and also if it becomes entrenched it becomes hugely problematic because the price of your debts usually aren't falling they're fixed like if i borrow a million bucks and i'm making less money from selling my goods my loan isn't going down but everything i earn is going down so that's why you find these deflationary spirals it's what's happened in the united states in the 30s it's what happened in Japan more recently, and they can be very, very, very hard to break.

2:51So deflation is kind of the ultimate bugbear for any central bank governor out in the world. Yeah. And I think just to boil that down into one line, the problem with deflation is nobody wants to spend when there's deflation because prices are going down. You got to repay your debts for all these various reasons. It gives a disincentive to spending. And so the whole economy is just sort of stuck. And, you know, I think the deflation we're seeing now in China, a big reason for it is the just utter lack of consumer confidence. You can sympathize with what Chinese consumers are going through. They've just been through, I mean, this very serious scrape with economic precarity during zero COVID where people in the largest Chinese cities could not get access to basic food and medicine.

3:32It's just, I think the Chinese economic future is very uncertain. And there's also not a very robust safety net in this country. This is a place where the savings rate is very high because there's not a lot of government provision of kind of basic services. You have to protect yourself and your family by saving more. And, you know, without some kind of clarity about where the economy is going and if things are going to be all right, people are holding back for now on consumption. Yeah, I think that's a great point because if you have to save for all sorts of necessities of life or emergencies of life, you save more, you spend less that means that there's maybe always been this kind of deflationary potential in china but as long as the economy was going gangbusters you don't really see it but now frankly the economy has been slowing down in a sort of secular long-term way for a while now and then covid hit and the country had to lock down a lot longer than most other countries it's all come together in a very kind of nasty way and i mean china is now facing some of its biggest economic challenges in decades, in generations, really.

4:39Yeah. And there are people that would quibble with us talking about Chinese deflation because they'd say, well, let's be real, Ethan and Robin. It's really deflation pork prices. Pork prices are down 28%. If you get rid of the pork, then actually inflation is positive right now. And I take that point as far as it goes, but it seems to me that that kind of is missing the forest for the trees to focus on just one price category. So it's actually right that we shouldn't go crazy looking at this one reading in one economic data set right and and it's true that china is probably not going to go into some 20 30 year deflationary spiral that struck japan or maybe the big deflationary fight that the united states face after the great depression but there's always something that is pulling inflation up and down and you can kind of jigger around the numbers by focusing on one or excusing the other.

5:33And I still think it shows the underlying problem in China, that the economy is slowing down. It has a problem in the real estate sector. Youth unemployment is high. And as you talked about, people just save a lot of money there because they don't have the social safety nets that they have in many other countries. So I think that brings us, Robin, to our next categories. Now let's talk about Chinese exports. These fell 14.5 % in July, really not a great number. And I think what's interesting to me is if you look at a big picture chart of where exports are, they're falling for sure, but they're not quite collapsing.

6:11And a big reason for that is Chinese exporters have slashed the prices on their exported goods to make them more competitive in international markets, which from kind of the business's perspective, that's a pretty savvy move. From the economy's perspective, you don't want to be marking your own stuff down. You want to have some confidence that this is a quality product that can command a premium price in international markets. That's not what Chinese exporters are doing. They're saying, we're seeing soft demand out there in the world, and we got to cut to stay competitive. Yeah, I have to admit, this is one of those areas I'm a little bit more optimistic, or I think this is kind of bad news that is actually good news.

6:47So China is now struggling a little bit with deflation, but obviously in the rest of the world, inflation is the biggest problem so the chinese manufacturers the chinese exporting machine cutting its prices is actually going to help the rest of the world they're going to be essentially exporting some of their deflation to the rest of us and that is a good thing and more broadly china has basically been a fairly lopsided economy for a very long time certainly for economy of that size it has relied for too long on just selling stuff that the rest of the world wants or needs or or is willing to buy.

7:24And what the Chinese authorities have been trying to do for a while is kind of rebalance the economy towards more consumption, becoming more US style, that is driven by as much external demand as internal demand. Ordinary Chinese people spending some of those savings and earnings buying stuff. So, you know, you want to see Chinese exports fall. And if they are falling because they are cutting price, that is not great for the Chinese company in question, if it's selling steel rivets or whatever. But it is not a bad thing for the world. And it's not necessarily, in the big scheme of things, a bad thing for China as well, if they manage these other challenges around that and don't get trapped into this nasty deflationary spiral.

8:09It's interesting you mentioned this point about China exporting deflation to the rest of the inflationary world. I just wrote last week in the Unedged Newsletter, I think that narrative is a little bit overdone. That if you look at the types of things that China's exporting, it's not the kind of inflation that a lot of global central banks and developed economies are worried about. Well, Ethan, I'm afraid we can't be friends anymore then. Yeah. Podcast over. Broadly speaking, goods are still a big component of any sort of inflation basket, the way we measure inflation. And if goods are pulling things down and services pulling things up, you'll still see a stabilization.

8:46And broadly, service inflation is another way of saying wage growth. And that is something we do want. We want people to make more money, as long as it's sustainable, of course. So broadly speaking, service inflation, yes, it is harder to manage to get down because frankly, the only way of doing so is to make people poorer. But it is still a symptom of an underlying strength in the economy, certainly in the United States and a lesser extent elsewhere, that, you know, people have money to spend and they expect higher wages. And if we can couple that with falling goods prices, which was a big bottleneck for a long time after COVID and, you know, Russia invading Ukraine and all sorts of other issues, then actually that doesn't strike me as a terrible way that it's, it's not the perfect, what people call the immaculate disinflation, right?

9:37But it is a good disinflation. It's a disinflation I will totally happily accept, at least on my bath. Thus concludes the US economy sidebar in the episode about the Chinese economy. It's all about the United States. I hate to say it. I'm Norwegian, you're Canadian, but really, it's all about the United States, unfortunately. I'm totally not Canadian. I'm from California. Oh, really? Okay. You're so polite, though. I thought you were way too nice to be American. We're nice people out on the West Coast. It's easy weather. I won't say too much about my East Coast brothers and sisters, but I was struck by the attitudes on this side of the country.

10:12Anyway, moving on. So that's exports. Now that I've defamed the East Coast of the United States where I live, that's exports down 15%. The last category of bad Chinese economic data is probably the most important, and this is the property sector. This makes up about a quarter of the Chinese economy, which is, you know, that's a much bigger share than real estate and property makeup and a lot of other similar economies. Property sales in China between January and July of this year contracted 9%. And that's after a whole bunch of contractions the year prior. You know, this sector of the economy is really struggling.

10:48And I think people will have heard about this and are familiar with some of the property problems that have been going on in China for several years. A couple of years ago, the big name was Evergrande, this big developer that just defaulted. More recently, there's one called Country Garden, which has missed payments on some bonds. But this is a broad problem that has built up over several decades. China pursued a real estate investment driven economic growth model, which involved a lot of borrowing to finance development. And then eventually there were enough houses for everyone and then some.

11:18And so the additional surplus houses have no value. and the developers are super burdened with debt and no one's going to buy their apartments. That's how I'd sum it up just very simply. And now we're kind of coming to the reckoning that everyone expected we'd come to, Robin, after years and years of predictions of China being the bubble that would eventually burst. I remember these predictions going back to, well, frankly, even before the global financial crisis, but certainly afterwards when one of the ways China kind of got itself out of the hole, and frankly helped the entire world to its credit, is by just opening the credit spigots and build, build, build.

11:55They just built this incredible amount of random stuff around the country. And I think people still don't really have their arms around the scale of how much building has been happening in China. For example, when I was covering the European crisis and Greece was going down the drain, China was essentially building the equivalent of Greece once a quarter, I think, at one point. It was just insane. But then obviously, we've seen this before as well, these big massive building booms, and China still needed to build infrastructure, railways, hospitals, schools, housing, all these things. It just went massively overboard.

12:32And apparently, I'm not allowed to swear on this podcast, but it is a very crummy situation. It is a giant crummy situation that is going to be very difficult to resolve. And even if they do it in the best way possible, it will likely take decades to get on top of this. This is going to be one of the biggest macroeconomic hangovers in the history of the world. So that's deflation, falling exports and contracting property sales. I think maybe we should just zoom out and talk about what we make of all this. One of the things people have been talking about in the past few months, and you alluded to this earlier, Robin, is are we seeing something in China similar to what we saw in Japan in the late 90s where there's a big bubble and a bunch of assets and then it bursts and then the whole economy is stuck in this kind of deflationary muck for decades and decades?

13:23And economists have a term for this. They call it a balance sheet recession. And it sounds complicated. It's actually quite simple. Everyone's borrowed a lot, put a lot of debt on their balance sheet on the way up. and then all of a sudden they're like, oh, I have borrowed too much. Let's all repay that debt right now. And that means everyone stops spending on new goods and services, redirects that money toward paying down old debt. And so spending falls, the economy slows, everything just gets, again, stuck in that deflationary muck. And it's really hard to get out of. What do you think at this juncture, Robin?

13:55Are we in a balance sheet recession in China? Yeah, I would say we are. Not right at the start, but in the early stages. I think the issue is whether it's going to almost escalate into more of a Japanese-style scenario, where we're talking a multi-decade period, which people, in Japan they used to call it the lost decade, but then it became three decades almost, and they're only really kind of extracting themselves from that now. So China, I would say, is experiencing right now kind of a classic balance sheet recession. They still have levers to pull. the government still has financial wherewithal where they can spend money you know again they're just kind of softening the blow but they have levers they can pull to avoid the kind of the not quite the armageddon situation but the kind of intractable multi-generation situation that japan found itself in but right now i think we can comfortably say china is suffering from exactly what you describe and will do so for a while yet and the question is whether it escalates from kind of being centered around the property sector and becomes this broader economic issue because like ordinary chinese people haven't borrowed that much money it's local governments developers and so on and i think they can solve that but it's going to be fascinating probably one of the macroeconomic stories to fall in the world over the next 10 years or so.

15:27I will say, I find it slightly odd that we're talking about a recession when growth is still expected to come in at like four or 5%, right? Like even in a bad scenario, growth comes in at like 4%. So you're right that economic growth in China is still fine. It's just slowing down from a very high rate and China should be slowing down. It's what you'd expect from a country that is you know becoming richer far richer than it was 10 20 30 years ago but the other big headwind in china's demographics and this is one thing that's been a huge challenge in japan that is just getting old and the problem is like old people well you know they don't spend as much money as young people they tend to be deflationary so the question for china is can it get rich before it gets old.

16:13Old people are the worst, so says Robin Wigglesworth. They are, amen. All right, listeners, we'll be back in a moment with Long Short.

16:30Welcome back. This is Long Short, that part of the show where we go long a thing we love, short a thing we hate. Robin, I'm short cable news. I was walking across the office yesterday, Just, you know, we got some cable news channels on and I took one look at CNN and you know what I saw was a four person panel featuring Jake Tapper and Jonah Goldberg diving deep on Vivek Ramaswamy raps Eminem at the Iowa State Fair. They had full court press coverage of this dude polling in third place, rapping an Eminem song. And you know what? As a print journalist, maybe we're elitist for thinking this, but come on, guys.

17:04Come on. I'm short cable news. Yeah, I mean, maybe it's also throwing stones in glass houses, archaic news and media, but I'm with you. I think cable is the worst, really. Are you long something, Robin? I am long. I am long Argentina, but for very cynical, self-serving reasons. I would never actually recommend anybody put any money into Argentina, but that's why I'm long it. Argentina is the economic story that keeps on giving a financial journalist like me. I mentioned that I love sovereign debt crises, and Argentina has more of them than almost any country in the world, right? And there's an old joke in macroeconomics that there are only four types of economies, really, when you boil things down.

17:44There's developed economies, there are developing economies, there's Japan, and then there's Argentina. And Argentina is just a wild, wild special case. Robin, you're making me feel like a fool for having done a whole economics degree. I mean, I could have just read that from you. You know, people have sustained entire careers in academic economics just writing about Argentina. All right, Robert, thanks for being here. We'll have you back very soon. And listeners will be back in your feed on Thursday with another episode of Unhedged. Catch you then. Unhedged is produced by Jake Harper and edited by Brian Erstad.

18:18Our executive producer is Jacob Goldstein. We had additional help from Topher Forges. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, and Jess Trulia. FT Premium subscribers can get the Unhedged newsletter for free. A 90-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Ethan Wu. Thanks for listening.