China: The Bubble That Never Pops

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The Chinese economy appears destined for failure, the financial bubble forever in peril of popping. And yet, the coming collapse of China is always coming, never arriving. In his latest book, “China: The Bubble That Never Pops”, Tom Orlik, a veteran of more than a decade on the ground in Beijing and Shanghai, turns the spotlight on China’s fragile fundamentals, and resources for resilience. In a piece which first appeared in the 2020 Vol 3 edition of the AmCham China Quarterly, Orlik, Bloomberg’s Chief Economist, explains some of the implications of the current US-China economic environment, tracing how we got to this point, and what happens next.

Q: There have been so many areas of concern for the China bears to highlight over the years, but the bubble still hasn’t popped. Why is that? And will the bears continue to be disappointed?

Tom Orlik: The China bears – among the grizzliest in the global markets – have got it right on the problems. China has borrowed too much. A lot of the borrowers are low quality – hulking state-owned industrial firms, real estate developers building ghost towns in the desert, and local governments building roads to nowhere.

What they get wrong is underestimating China’s resources for resilience. A high savings rate means China’s banks are well funded, and banks that are well funded don’t fall over. Average incomes a third of the level in the US mean China still has room to grow out of its problems. And, in contrast to the US ahead of the 2008 financial crisis, China’s policymakers have identified the risks and taken steps to contain them. The bears may have to stay in their cave a while longer.

Q: You wrote this book before the pandemic added a new layer of uncertainty. Do your theses in the book still hold true? How has COVID-19 changed things?

Orlik: COVID-19 is a human tragedy. It’s also a stress test for economic and financial systems. So far, China’s is holding up better than most. With the banks well funded, they could afford to give lockdown-afflicted borrowers a break on repayments. That meant they could ride out the crisis without worrying about defaulting on their loans. It also meant financial stress was contained, and – once the virus was under control – China’s economy was primed for a rapid recovery.

Q: Why haven’t we seen massive stimulus this year, as we saw after the financial crisis? Is that still waiting in the wings?

Orlik: Premier Wen Jiabao’s famous four trillion yuan stimulus saved China from the 2008 crisis. It also brought problems of its own. A stimulus that ran too far for too long left China with a legacy of debt. And a lot of the benefits of stimulus spilled overseas – helping Australian iron ore miners as much as it did local workers. This time, with less space to act, and determination not to repeat past missteps, China has run a stimulus that is smaller in size but targeted more effectively.

Q: China’s economic recovery appears to be happening much more quickly than elsewhere. What are the global implications of this?

Orlik: China’s rapid recovery is good news for the rest of the world. Foreign multinationals may see revenue rebounding in China before it comes back at home, for example. At the same time, as the trade surplus touches fresh highs, some of the old concerns about China gaining more from exports than it gives back in imports are coming back.

Q: With the US and Europe struggling to recover, will that result in reduced demand for China’s exports? How significant a concern is this, particularly with regards to China’s employment situation?

Orlik: One of the strange features of the COVID-19 crisis is that global demand has been crushed, but China’s exports remain buoyant. There are a couple of factors at work. First, China is a big producer of medical equipment and pharmaceuticals. Second, in some countries the virus lockdown has put domestic firms out of action, thereby reducing the competition.

Q: China has taken some steps to reduce its debt burden and had had some success in deleveraging. How were they able to do that, and has it been enough?

Orlik: Back in 2016, when Beijing kicked off its deleveraging campaign, the conventional wisdom was that the government faced an impossible task. In fact, they got a lot done. The debt to GDP level went from rapid increase to stabilization. Shadow banking – the riskiest part of the system – was effectively turned off. And because they were a bit tighter in the good times, they could afford to allow lending to rise a bit higher when they needed it during the COVID-19 crisis.

Q: We saw some bank bailouts last year – the first ones in a long, long time – and this year, some of the smaller ones have being merged. Is this a smart strategy? What other policy moves do you expect to happen in the future?

Orlik: China’s small banks are a key fault line in the system. Many have a shaky funding base. Some are sitting on a lot of hidden bad loans. We saw with the collapse of Baoshang Bank how that can be a toxic combination. A lot of the deleveraging campaign was about tackling those problems. The big question is whether small bank stress could ever add up to a system shaking shock. So far, the answer has been no.

Q: “Dual circulation” appears to be the new buzzword phrase in Beijing these days. Is it simply rebalancing dressed up in a new way, or is there more to it than that?

Orlik: One of the big mistakes that Washington DC makes is assuming that only the US gets to decide how the bilateral relationship looks. In fact, Beijing is deciding as well. The trade war and COVID-19 shock make a pretty convincing case that they should reduce dependence, be more self-reliant. The dual circulation economy is part of that. I guess you could say it’s a buzz word, or a campaign slogan, but there’s substance there as well.

Q: Just how important is foreign direct investment (FDI) to China? Does the country’s emphasis on FDI hamper or conflict with its efforts in dealing with the US on disputed trade issues?

Orlik: FDI can be important for two reasons – as a source of funds and as a conduit for technology and expertise. On the first, because of its high savings rate, China doesn’t really need any foreign funds. On the second, it’s still important, but as China gets better at innovating at home, it’s less important than it was.

Q: What are the biggest challenges and opportunities you see for foreign companies in China over the next year or more?

Orlik: The development of China’s financial system is a real opportunity. You’ve got the biggest pool of savings in the world, all the potential that comes from the massive e-payment system, and a market that’s opening wider to foreign investors and institutions. Of course, there are risks as well, including talk of financial decoupling. But it’s one of those areas where combining foreign and local expertise could generate some real wins.

Q: US-China frictions have seen reduced cooperation in several areas, including the scrapping of almost all mechanisms for economic dialogue. How much of an effect has that had, and do you see any channels for economic communication reopening in the future?

Orlik: Tariffs on billions of dollars of goods, sanctions on technology companies, consulates closed – this is clearly not a great moment for US-China relations. At the same time, from financial reforms to climate change, there are a lot of areas where there is an opportunity – indeed, an urgency – to work together. Let’s see if the months ahead provide an opportunity for a reset.

Q: Since moving to the US from China last year, what has struck you about the relationship that perhaps you weren’t previously fully aware of?

Orlik: There’s this strange view of China you often encounter here in the West. On the one hand, there’s a fear that China is too powerful and they’re going to take over the world. On the other, there’s an assumption that China’s financial system is broken, they have too much debt, and they’re going to collapse. Those views can’t both be true at the same time. In my book, I call it Sinophrenia. It’s a real problem, and I think that unrealistic view of China makes it harder to have a constructive relationship.

Q: When you’re not poring over the latest economic numbers, you’re a keen table tennis player. Is it time for another round of ping pong diplomacy to get the US-China relationship back on track?!

Orlik: Yes, and I’m available. 加油!

This article originally appeared in the AmCham China Quarterly magazine, 2020 Vol 3, which can be downloaded directly here.