Will China’s bubble finally burst?

Domestic News

Tom Orlik, Bloomberg's chief economist, returns to discuss the updated edition of his book — and whether the property crisis, “common prosperity,” tense foreign relations, or the COVID lockdowns are finally going to bring about the crash long predicted by the "China bears."

Illustration by Derek Zheng

Below is a complete transcript of the Sinica Podcast with Tom Orlik.

Kaiser Kuo: Welcome to the Sinica Podcast, a weekly discussion of current affairs in China, produced in partnership with The China Project. That’s right, from September 1, as you hopefully already know, we are changing our name from SupChina to The China Project. Subscribe to Access from The China Project to get access to, not only our great daily newsletter but all the original writing on our website at thechinaproject.com. We’ve got reported stories, essays and editorials, great explainers and trackers, regular columns, and of course, a growing library of podcasts.

We cover everything from China’s fraught foreign relations to its ingenious entrepreneurs, from the ongoing repression of Uyghurs and other Muslim peoples in China’s Xinjiang region, to Beijing’s ambitious plans to shift the Chinese economy onto a post-carbon footing. It’s a feast of business, political, and cultural news about a nation that is reshaping the world. We cover China with neither fear nor favor.

I’m Kaiser Kuo, coming to you from Chapel Hill, North Carolina. Joining me from the other side of the Appalachians is a man who only picks quarrels and provokes trouble while strolling the streets of Beijing and other Chinese cities wearing a kimono, the one and only Jīn Yùmí, a.k.a. Jeremy Goldkorn. Greet the people, won’t you?

Jeremy Goldkorn: Oh, Kaiser, that was a pretty ridiculous one. You’re referring, of course, to the poor young lady in Suzhou who was arrested, a cosplayer, she was, for just walking around the streets of Suzhou in a kimono.

Kaiser: Unforgivable there.

Jeremy: Apparently, wearing a kimono is kind of evidence that you are a traitor, anyhow.

Kaiser: Wow. Jeremy, you’re joining the podcast for a second week in a row. It must be slow over on the newsletter side of things. Are you excited, though, about the name change?

Jeremy: Yeah. No, not slow. Not slow at all. The name change is great. So, we’re going to be The China Project, which means, hopefully, certain people who thought our old name was a bit ridiculous are going to love the new name. And we’re also, we’ve been launching a lot of new stuff. We have a new YouTube show, Live with Lizzi Lee, in which Lizzi interviews all kinds of interesting and influential people who know about China, and business in China, and politics. And we have a new TikTok channel by a young lady by the name of Susan St. Denis. And if you are into TikTok, it’s called ChinaVibe. Go check it out. It’s really good. And I say that as someone who doesn’t actually like TikTok, anyhow.

Kaiser: Well, I love that channel. I think she’s fantastic. I think she represents our viewpoints very, very well.

Anyway, a little over two years ago, in June of 2020, Bloomberg’s chief economist, Tom Orlik, joined me on the show to talk about his then-new book, China: The Bubble That Never Pops. I think Jeremy was speaking at a QAnon event and couldn’t make it at the time. Isn’t that right, Jeremy?

Jeremy: Yeah.

Kaiser: That was, of course, just a few months into the pandemic, and with this weird time dilation fact that COVID seems to have had, it does feel like an awfully long time ago. Certainly, a lot has happened in the time since, and Tom has a revised edition of the book coming out any day now at a moment when, once again, there are a lot of people who are convinced that this time it really will pop. So, we’ve invited Tom back onto the show to talk about what’s new in the book to see whether events of the last couple of years have either reinforced or caused him to rethink his earlier positions and to get his take on the current situation.

Jeremy: In March of this year, I had a brief conversation with Tom, from my “Invited to Tea” Q&A column for the website, where we talked about, among other things, the reasons why he doesn’t think setting GDP targets is such a bad idea. And I would encourage anyone interested in more to read that column, which you can find easily by just searching for Tom’s name and my name, and SupChina.

Kaiser: Yeah. Anyway, Tom Orlik, welcome back to Sinica, always great to have you, man.

Tom Orlik: Great to be here, Kaiser, Jeremy. Before we kick off, I’ve got one burning question for Jeremy. Jeremy, when you spoke at the QAnon event, were you wearing a kimono or was that a late…?

Jeremy: You’re giving away my secrets, Tom, and I’m going to be in trouble on both sides of the Pacific. We’re going to have to change the subject now.

Kaiser: Yeah. I have a great way to change the subject. Tom, I think we should start off with a little bit of a recap for those of our listeners who didn’t hear our podcast with you two years ago or who haven’t read the first edition of the book. So, as succinctly as you can manage, what are the main reasons that the China bears had, at least recently, been so fundamentally wrong? Why has the Chinese bubble not popped?

Tom: So, I lived in China from 2007 to 2018. And throughout that time, there was a thread of pessimism, even a thread of doom running through the Western commentary on China’s economy and financial system. Yes, we said the headline growth numbers look impressive, but if you poke a little bit beneath the surface, what you discover is that it’s a Potemkin village. The boom is built on an unsustainable basis with a huge build-up in debt and an outsized role for big inefficient dinosaur state-owned enterprises. So, it can’t last and it’s going to end in a bust. And as I was packing my bags in 2018, I sort of looked around and had a rare moment of self-awareness and realized, you know what? This bust we’ve been predicting for the best part of the last two decades doesn’t seem to have arrived. So, as I put pen to paper for my book, I was trying to explain why.

The conclusion I arrived at was that the China bears aren’t wrong in their identification of the problems. China does have too much debt. It does have a big inefficient state sector of the economy, but what the China bears fail to recognize is that China also has countervailing sources of strength. Debt is too high. Banks have made too many loans. Many of those loans, more than the banks acknowledge, have probably turned bad, but China’s banks also have a really, really stable funding base. And banks with a stable funding base don’t normally fall over. State-owned enterprises are big and they are inefficient, and they can be a drag on growth, but they’re also engines of development. They’re instruments which China’s government uses to build the infrastructure which the country needs to move up the industrial value chain.

And they’re also instruments which the Chinese government can use to right the ship coming out of a slump, like the second quarter slump following the COVID lockdowns in Shanghai and Beijing. It’s the state sector which leads the charge, beginning capital spending, beginning to hire more workers at a moment when the private sector is still too cautious to get the economy going again.

Jeremy: But, of course, Tom, as Kaiser said, a whole lot has happened since we last spoke on the podcast and since you published the book. Obviously, it’s almost impossible to write a book on something as fast moving as the Chinese economy that will stay relevant for years. You were, in fact, able to write a chapter on the covered response. And that chapter, given China’s rapid recovery, was still fairly sunny. And you did have a postscript about the common prosperity agenda, which we were all talking about for some months. We were calling it the red new deal, you might remember. But, of course, things changed again with the Shanghai lockdowns and all, and things are looking quite a lot less sunny than they were in the earlier months of the pandemic. We’ll get into this a little later this hour, but generally speaking, is China looking quite as clever as it was four months ago?

Tom: So, if we were having this conversation at the end of 2020 or the end of 2021, China’s response to the COVID pandemic looked pretty formidable. Yes, there are some big unanswered questions about opacity, both in terms of failing to share information with the Chinese people and the rest of the world right at the beginning of the pandemic. But in terms of containing their domestic outbreak, saving lives and getting the economy going again, in 2020 and 2021, China’s policy-makers looked pretty clever, certainly pretty impressive relative to most of the rest of the world. Right now, the situation looks considerably different. Here, in the United States, in Europe, at an enormous expense in human life, let’s not forget that more than a million people have died here in the United States and hundreds of thousands of people have died in Europe, populations have achieved a measure of resilience, a measure of immunity to the COVID virus.

And that means that the economy is open, people are back in the office, children are back in school, and daily life looks, well, not quite like it did pre-COVID, but not too far away. In China, because there’s been no widespread outbreak, and because there’s been no move to acquire the advanced mRNA vaccines, which give a high level of resistance or immunity to the virus, the population is still COVID naive. And we’ve seen some of the big costs of that in the Shanghai lockdown in the second quarter of this year. We’ve seen the enormous negative impact it has on growth. We see the problems continuing with lockdowns in Hainan, China’s island holiday destination. And there’s still a big unanswered question, how does China exit from COVID-zero, and how costly will that be in human lives and in economic growth?

Kaiser: Yeah, yeah, absolutely. Well, it’s kind of a Catch 22. I mean, the immunological naivete is kind of a result of China’s early successes, and now that is precisely what’s keeping it from being able to open faster in the absence-

Jeremy: Well, also, the fact that they don’t seem willing to import vaccines and thus kind of show up the fact that the Chinese vaccines aren’t that great. Isn’t that the other factor?

Kaiser: The thing is we don’t really know, because there are so few COVID cases, how the Chinese vaccines perform in terms of reducing hospitalizations.

Jeremy: As a cynic, I can offer an interpretation of that, Kaiser, but let’s not get stuck in a COVID argument.

Kaiser: Let’s move on.

Jeremy: I have a QAnon meeting to go to later.

Tom: And a kimono to press ahead of that.

Jeremy: That’s right.

Kaiser: Tom, you used the same phrase that I’ve used before when talking about Chinese experience of recent years, stress test. Though, you used it mainly to talk about the economic system. What was this stress test? How did the Chinese economy fare in the early months of 2020 and so forth? And what conclusions do you think the leadership drew from that?

Tom: So, if we are to believe the China bears, the pessimists on China’s economy who say that it’s on the verge of collapse, then China’s debt is so high and China’s state-owned enterprises are so inefficient, and China’s leaders, so incapable of acting effectively that when a huge challenge came along, and clearly COVID was a huge challenge, China’s economy should have collapsed.

And that’s clearly not what happened. In the first quarter and the second quarter of 2020, the economy locked down, but because the banks are well funded, they could continue operating, they could extend forbearance to businesses who had shut down and were temporarily unable to repay their loans because state-owned enterprises can act, from time to time, on national priorities, rather than a sort of narrow quarterly results basis. They could hold on to their workers. And once the economy was reopened, they could catalyze the recovery by beginning more investment projects and bringing more workers on.

I think, in some respects, at least in 2020 and 2021, China passed the COVID stress-test rather well. In an important other respect, though, I think COVID has underscored some of the bigger weaknesses of the Chinese system. So, China has pointed at the problems of democratic systems, which were evident during the COVID crisis. Democratic systems where everybody has a voice and no one can tell anybody what to do were not able to contain the virus, not able to even have people do common sense things like wear masks. And that had some terrible consequences here in the United States and in Europe.

But non-democratic systems, single-party systems, authoritarian systems, like China, also have some very serious weaknesses. And one of those weaknesses is that they find it too hard to listen to critical voices and too hard to move away from the wrong policy, even when it’s clear that it’s the wrong policy. And I think we’re seeing that now with COVID-zero.

Kaiser: Yeah, yeah, yeah. I would tend to agree.

Jeremy: Tom, in response to the Great Financial Crisis that seems like ancient history right now, 2008, 2009, China opened the stimulus taps and coordinated with the United States. And the conventional wisdom now around the world seems to me to be that China was very successful and that the benefits weren’t just seen by China, but the whole world actually benefited from China’s handling of the crisis and from the stimulus. Now, it comes to COVID, the U.S. economic policy response has involved impressive amounts of stimulus. I think people are starting to argue now that there was too much of it actually. But it wasn’t much by China, at least not in 2020 or 2021. What was behind that lack of interest in stimulus? Why did they not do a stimulus program back then? And why are they apparently opening the taps now?

Tom: So, I think there’s a couple of reasons for it, Jeremy, and they both actually go back to what in China is viewed as the failures of the stimulus back in 2008 and 2009. Yes, China’s stimulus back then, the sort of famous Wēn Jiābǎo 温家宝 $4 trillion UN stimulus and all of the bank lending and investment, which that catalyzed, it restarted China’s growth. But it also put China on an unsustainable trajectory. Debt rose too high. It proved very difficult to turn the lending taps off. And that has contributed to the high level of financial risk in China, which is one of the reasons they can’t now run a massive stimulus. Debt’s already too high, they’ve kind of maxed out. The other reason is, well, you mentioned that the 2008, 2009 stimulus was a kind of a generous stimulus, a stimulus that restarted the global economy, and that’s true.

And China, of course, will take the positive PR from that as they took the positive PR, for example, from their decision to stabilize the yuan during the Asian financial crisis back in the 1990s and provide a kind of anchor for stability in the region. But being generous to the rest of the world isn’t normally an objective of national economic policy. Here, in the United States, Jerome Powell at the Federal Reserve or Janet Yellen at the Treasury don’t think to themselves, how can I set an optimum economic policy for the rest of the world? They think to themselves, how can I set an optimum economic policy for the United States? And that’s the same in China. It was a kind of desirable side effect for the rest of the world that China’s stimulus was so generous in the great financial crisis, and did catalyze a huge amount of commodity demand, for example, good news for the Australias and the Brazils of the world.

But from China’s perspective, that wasn’t actually what they were aiming for. It wasn’t a huge positive. And they’ve actually become smarter about how they can deliver stimulus now, so they can deliver more benefits at home at a smaller cost and with less spillovers to the rest of the world.

Kaiser: So, what’s the, the next round of stimulus looking like? What form will it take?

Tom: I mean, perhaps we’re going to want to get into this a bit in the discussion, but China’s got two really big problems right now. So, the first really big problem is COVID-zero and how to exit from that, and the drag on growth that comes when you have to lock down big cities, even entire provinces. The second problem is what’s happening in the real estate sector. Real estate’s the biggest driver of Chinese growth, but it’s on an unsustainable trajectory, too much building, too much debt. And the attempts to kind of right the ship have triggered a significant downturn with sales, construction, and prices for China’s property now, all falling. Now, those two problems are difficult to solve at the same time, right?

Kaiser: Right.

Tom: If you want to solve the real estate problem, you want to pump a bunch of stimulus into the economy. If you want to maintain COVID-zero, actually, pumping a bunch of stimulus into the economy can push in the other direction.

Kaiser: Right. I see. Yeah. It’s a tough nut to crack. And we will, as you say, get into both of these problems a little more extensively. But first, let me ask, “dual circulation” was a thing not too long ago. We talked a lot about, especially the sort of boosting of domestic demand, this was the initial response, I think, after the first big COVID wave in the spring of 2020. That policy was sort of rolled out in May or June of that year. Have we seen continued growth in domestic consumption as a percentage of GDP? And is this a priority right now for Beijing?

Tom: So, one of the problems with the COVID pandemic is that it has made the various different imbalances in China’s economy even worse. One of the big imbalances in China’s economy is too much reliance on investment and exports to drive growth and not enough of a role for the domestic consumer. What’s happened during the COVID lockdowns is, well, the government has been much better at keeping industry going than it has at keeping consumption and services going. And there’s an obvious reason for that, which is, if you keep growth going by having a bunch of people continuing to go to work in their hygienic factories, you can probably control COVID. If you keep growth going by encouraging everyone to go to restaurants or nightclubs or tourist sites, well, that’s going to be pretty bad for containing COVID.

So, the dual circulation economy aims to boost domestic demand. And the pressing need to address the imbalances in China’s economy mean that there’s a need for more consumption. But the patent over the last two years, because of the overarching need to contain COVID, has been; industry has done well, exports have done well, but domestic consumption, especially consumption of services has suffered.

Kaiser: Yeah. So, that seems to have been sort of back burnered a bit. Let’s talk a little bit about the common prosperity agenda. We talked just now about stress-tests, and in various talks that I gave last year, I often said that China’s governance system had undergone a series of such stress-tests in recent years as well, beginning with the trade war and American efforts to kneecap Chinese tech, the opprobrium that China had suffered because of Xinjiang, of course, because of the massive extralegal internments there, and of course, the crackdown in Hong Kong, and most recently, the COVID pandemic. And Beijing felt, though, that it had emerged from this, at least when they were rolling out this common prosperity agenda, that they felt like they had passed the stress tests with flying colors at levels of regime support, of political capital and credibility had never been higher.

And for that reason, I was arguing China was ready to break eggs and make an omelet. And that omelet was this whole common prosperity package, this red new deal. Addressing the primary contradiction that they decided was in 2017, the main contradiction in society, the whole range of social ills putting the economy on a totally different footing, to what extent has now this whole agenda been derailed? Have these ambitions been backburnered or scaled back? Are they, maybe, still moving forward just without so much fanfare?

Tom: So, common prosperity agenda has got a lot in it, right?

Kaiser: Yeah.

Tom: You’ve got the canceled Ant Financial IPO. You’ve got the smackdown of Didi for having its IPO here in the U.S. You’ve got the anti-monopoly crackdown on the big tech companies. You’ve got the crackdown on the entire online private tutoring industry. So, there’s a lot which kind of comes under the umbrella of common prosperity. Now, many people, not people here on the Sinica Podcast, which is so balanced that I’m surprised you haven’t got the Guild of Tightrope Walkers throwing bricks through your window because they’re scared about the competition, but some people who don’t have the balance of the Sinica Podcast have been quick to kind of scone the common prosperity agenda. And say, “This is a Chinese Communist Party that hates entrepreneurs that can’t stand any challenge to their power,” and which is kind of capricious and unpredictable and throws destabilizing policies out there without any thought for the consequences.

My take on it is a little bit different. And I think it’s reflected in your characterizing it as a red new deal, right? I think, actually, if we think about the objectives of the common prosperity agenda, let’s have a more equal society, let’s constrain the power of some of the tech monopolies, which have grown so quickly and now have such an enormous influence over the economy and over our lives, those are not specifically Chinese objectives. Here in the United States and in Europe, there’s also a desire to have more equality. There’s also a desire to constrain the power of the giant tech monopolies. I tend to think that we can find, kind of, an explanation for the common prosperity agenda. Not in the kind of capriciousness and perniciousness of the Chinese Communist Party, but rather in the kind of social policy objectives that we see here in the United States, here in Europe, and guess what? in China as well.

Now, even if we agree that achieving a higher level of equality and constraining the power of the tech monopolies is a good idea, I think many people would agree that it is a good idea, it does come at a cost. That cost is a cost of growth. Now, if you’re sitting in the middle of 2020, and you think you’ve solved COVID and the economy’s booming, you probably think to yourself, “Yeah, I can pay a bit of a cost in terms of growth. I can pursue these kind of farsighted long-term social objectives, and GDP will be a bit lower, but I don’t care.”

Kaiser: Yeah. After all, you’ve just had this instance in where you’ve suffered short-term pain for enduring gain, like the whole V-shaped recovery thing, right? China tanked its economy quickly right away and then bounced back, right? So, that was the lesson.

Tom: Yeah. I think that’s exactly right. I also wonder if that experience of the COVID lockdowns, where the economy didn’t grow and there wasn’t an enormous problem is actually going to prompt a longer-term reevaluation by China’s policy-makers on what level of growth is acceptable. If the economy can grow 0% or even contract without there being massive problems, perhaps they don’t need to be targeting 5%, 6% a year. But back on the common prosperity agenda, from where they are in 2022, still dealing with COVID-zero, now dealing with a very, very challenging real estate slump, I think they probably think this isn’t a good time to pursue those farsighted objectives, which come at a cost in terms of short-term growth. And so, yes, it wouldn’t be surprising if they were putting them on the backburner.

Kaiser: Yeah. Some of the controls have been kept in place, like fintech companies, they’re not really letting up on the cram schools that much. They’re still barreling forward and pushing toward hard tech, away from the tech sectors that the party seems to think are more frivolous gaming and that sort of thing. Yeah.

Jeremy: That was a feature of common prosperity, the push for chips for hard technology. Which I would imagine, Tom, is likely to continue, especially with the U.S. now, apparently trying to restrict even older generations of chip-making tools from export to the PRC. So, how would you say China is faring in its efforts to be more technologically independent?

Tom: So, one of the really striking things which has happened over the course of the COVID pandemic is China’s international reputation has been hammered. I’m sure Sinica listeners have seen that famous Pew survey which shows unfavorable views of China rocketing up in the United States, in Europe, and also amongst Asian neighbors. And part of the reason for that is the blame game over the origins of the COVID crisis, but there’s also more to it. People don’t like what they’re seeing in Xinjiang. They don’t like what they’re seeing in Hong Kong. And for China, this is a pretty significant problem. It’s a significant problem because China is an exporting nation. And in general, you want to have good relations with the countries you’re selling to. It’s also a problem, and this comes back to your question, Jeremy, because China is a net beneficiary of global technology transfer.

China is still playing catch up with the west on technology. And so, it has to import a bunch of things as part of its manufacturing processes, notably a bunch of semiconductors. And it is also working aggressively to try and assimilate technologies which it sees being used to drive higher productivity in the U.S., in Germany, in Japan and elsewhere. Now, of course, China is not blind to the fact that its international ties are fraying. That was already clear under the Trump administration with the trade tariffs, it’s become even more clear and kind of become… It’s become clear under the Biden administration that Trump wasn’t an aberration, and rather that global ties, U.S.-China ties are now permanently damaged. We’re not going to go back to the sort of happy relations we saw under Clinton, or Bush, or Obama. And that’s accelerating the Chinese drive for technology independence.

Now, in one really important area, semiconductors, China doesn’t appear to have made very much progress. And people point at that and say, “see, China can’t achieve technological independence. I don’t actually hold that view. I think, if you think about the history of the last 40 years, it’s the history of China throwing a huge amount of money at attempting to assimilate foreign technologies, starting with simple stuff, like how to make metals, and then moving up the value chain to things like trains and ships, and then moving up the value chain even further to stuff like sustainable energy. Throwing huge amounts of money at those challenges, failing, failing, failing, but then succeeding.

Once they succeed and they have that technology, they can operate at such enormous scale that they can effectively price out any of their competitors elsewhere in the world. So, so far, they’ve not managed to deliver that on semiconductors. And that’s sort of seen as a source of reassurance for the U.S., and Europe, and Japan and others, kind of, “Ha-ha, China’s trying, they’re throwing a huge amount of money at it, but they haven’t succeeded yet.” I think the lesson of the last few decades is yeah, they don’t always succeed at first, but that doesn’t mean they’re not going to get there in the end.

Kaiser: Right.

Jeremy: That’s something Kaiser and I used to hear a lot of, especially in the ‘90s, but the 2000s, in the sort of tech scene in China when most Chinese tech companies were basically copying their Silicon Valley peers. And then, suddenly, companies like Tencent came out with WeChat. And I think that was the first time when Western technology people suddenly got a bit of a fright, because they were like, hell, that these people can innovate. Anyway.

Kaiser: Yeah. Tom, you’d add to the litany of things that people outside of China don’t like the Ukraine war and China’s position in that, the Taiwan Strait situation, especially surrounding speaker Pelosi’s trip and China’s response, and, of course, the controversial zero COVID policy and the lockdown. Some pundits and some reporters are convinced that under all these accumulated external and internal stresses, we are now seeing cracks in the facade of unanimity within the highest echelons of the leadership. When it comes to economic policy, at least, because Lǐ Kèqiáng 李克强 is often invoked as the leader of this tacit opposition. What do you make of these claims?

Tom: I tend to view any claims about Chinese elite politics with extreme skepticism. I just don’t think that we have good sourcing for those claims. I don’t think anyone in the standing committee or the politburo, or the central committee, or the central committee alternate is sharing their thoughts on what’s going on inside Chinese elite politics with anyone who’s not already in that circle. That was what was so fascinating about that Bó Xīlái 薄熙来 moment, right? That huge scoop by Jeremy Page of The Wall Street Journal, back when Xí Jìnpíng 习近平 was jockeying for his position as general secretary. It was that it kind of opened a crack in Chinese elite politics. And for a moment allowed people to look into the kind of the reality and the conflict and the maneuvering, which was going on.

But I think that was a particular moment when there was a crisis and it opened a crack in the sort of facade and we could peer in. I don’t think that happens very often. I do hear these things from time to time, like Li Keqiang has a short-term view on the economy because he wants to get renominated, but Xi Jinping is already certain that he’ll have another term, and so he’s not so worried about it. That was one that we heard a few years ago. I tend to sort of have some skepticism about the basis of these claims.

Jeremy: So, it’s bullshit is what you’re saying. Okay. Tom, let’s go back to the real estate industry property and talk about the situation of Evergrande and the other big developers. With all the news about mortgage strikes, desperate exhalations to get patriotic carters to buy property to shore up the realty sector, I mean, is this the thing that could bring it all down and finally pop the bubble? Just today, the FT reported on how the property developer, Country Garden, which is another one of the biggest ones in China, estimated that first half profits fell by as much as 70%. How has Beijing tried to address this situation? Is it actually working?

Tom: So, real estate could be the thing which knocks China’s economy over. It could be the thing which finally means the Chinese bubble bursts and forces me to make an unpleasant call to Oxford University Press and ask if we can rename my book.

Jeremy: Why the bubble finally popped? What’s the…

Tom: Exactly. With the new preface on how I called it. If we look around the world and we sort of survey the history books, property plays a kind of starring role in financial crises. In 1989 in Japan, it was the bursting of the real estate bubble, which was the catalyst for the end of Japan’s development miracle and the beginning of its lost decade of zero growth and deflation. Here in the United States, the subprime crisis back in 2007 was the catalyst for the great recession and the global financial crisis. And in China, there’s a really serious problem. The fundamental demand, which drove decades of real estate boom, has started to dry up because of shifting demographics. Less people means less demand for property. And the end of the urbanization boom, which brought hundreds of millions of rural residents into the cities, and of course, they needed homes as well.

China’s property developers are overaged and have built too many houses, those ghost towns, which you read about, and it’s not a pretty picture. And we’re seeing now some indications that an unraveling is underway. Prices are down. Construction is down. Sales are down. Big real estate developers, you mentioned Evergrande, have defaulted. Other big developers, you mentioned Country Garden, have seen a very, very significant drop in profits. So, a systemic crisis is a possibility and I don’t rule it out. At the same time, it’s not my base-case scenario for a couple of reasons. The first reason is, if you look at the history of China’s real estate sector, it’s not a unbroken upward trajectory, it’s a series of peaks and troughs.

And what that means is that this is not China’s policymakers first rodeo when it comes to addressing a downturn in the property sector. They’ve been here before and they have a bunch of policy instruments, which they can use to turn the sector around. They can cut down payment requirements, they can cut mortgage rates, they can ease financing conditions for real estate developers. They began to do all of these things, they can do significantly more, if that’s what’s required, to prevent a systemic crisis. And the second reason is that we are where we are, in part, because of a deliberate policy choice by Beijing. Beijing decided in 2020 that it was time to put the real estate sector onto a sustainable trajectory. And they imposed significant restrictions on real estate developers’ access to finance. Now they did that because they wanted to address the problem of moral hazard in the sector, to address the kind of view of investors and real estate developers, that they could take on any risks. And if things went right, they’d make a huge amount of profit. And if they went wrong, the government would be in there to bail them out.

Now, addressing moral hazard means allowing some real estate developers to fail. China allowed Evergrande to fail. They allowed other big developers like Kaisa and Fantasia to default on their borrowing. They’ve moved to address the problem of moral hazard. But China’s policymakers are not crazy. They’re not going to take their campaign against moral hazard so far that it craters the entire Chinese real estate sector and spills over into problems for the banks, which tips the economy into a financial crisis.

Jeremy: Oh, and I should point out that Kaisa Real Estate Company has got nothing to do with Kaiser Kuo.

Kaiser: Well, that you know of, that you know of.

Jeremy: Oh, I see. I see.

Kaiser: I mean, I don’t think it’s a coincidence that they named it after me, right? So, Tom, what is Xi Jinping prioritizing right now as we move closer to the 20th Party Congress? I mean, it seems like there are an awful lot of fires to put out, a lot of simultaneous crises, both domestically. How is the leadership around Xi going about triage as it were?

Tom: So, it’s a really good question, Kaiser, and I’m afraid I don’t have a brilliant answer for you. I think it’s-

Kaiser: Okay. I’ll then put it another way. How would you, what would you prioritize? What do you think are the most urgent crises?

Tom: I think there’s two big problems to deal with. The first is COVID-zero and the second is real estate. And neither of them have an easy solution. On COVID-zero, the challenge is how to move from a country which is COVID naive to a country which has a measure of immunity, and so can reopen and resume kind of normal life and openness to the rest of the world. I’m not an epidemiologist. I don’t know exactly how China’s policy-makers are going to address that challenge. But when I think about how they address other challenges, what I generally see is a gradual incremental adaptive approach, right? Let’s not try and do everything at once. Let’s take a small step, see if we succeed, and then take another small step, retreat a bit if we have to, but keep things moving forwards.

For the exit from COVID-zero, I wonder if what that’s gonna mean after the Party Congress is a province by province or city by city approach to exiting. Let’s pick a province, let’s seal it off from the rest of China, let’s bring in all of the best vaccines we have, all of the healthcare resources we have, and then let’s let COVID go within that province so we allow that province to build up some natural immunity whilst hopefully minimizing the public health costs. And then let’s learn from that experience and try and do it better in the next province and better in the next province. And then, over the course of a year or a year and a half, you move the country from lockdowns and COVID naivety, to hopefully immunity and openness.

Kaiser: From your lips to Xi Jinping’s ears.

Tom: On the real estate crisis, I think there’s a bunch of stuff they’ve got to do. I think they need to ease macro policy, right? So, they need to cut interest rates, they need to cut a tool, which is kind of specific to China, called the reserve requirement ratio to free up more money for banks to lend. They need more fiscal stimulus. They need to encourage local governments to issue more bonds, to pay for more infrastructure building to offset the drag from property. They also need to take steps which are specific to the property sector. They need to cut down payment requirements. They need to cut mortgage rates. They need to ease controls on who can buy a home to encourage more people to buy property. Within the property developers, they probably need to have a kind of tough decision which separates preterit from the elect, right?

They need to say, “You property developers do not have a sustainable business model. We’re gonna allow you to go into bankruptcy. And you are the property developers, we think your finances look okay, we think you know to run your business, you are going to survive, and you’re going to take a larger share of the market, which ultimately will be more profitable for you. But guess what? You are going to need to help us out with the failed projects from these other developers which are going into bankruptcy.” And lastly, I think that, however, they do this, there’s going to be a bunch of defaults, a bunch of bad loans. And so, I suspect there’s going to be a need to recapitalize some of the smaller banks as well, to make sure that they have the buffer needed to withstand that shock.

Kaiser: And they surely are worried about social stability now with this phenomenon of the mortgage strikes and so forth. Are they prioritizing making the ordinary person, who paid for a property on which ground hadn’t even been broken yet and will never move into the place, are they going to make them whole first? Is that the plan?

Tom: So, in the financial world, when we think about a default, there’s a kind of hierarchy of investors who get paid, right? So, if you are a shareholder in a company, you are going to get wiped out. If you are a bond holder, who’s lent the company some money, then you’re going to get some of that money back, but there’s going to be a kind of a hierarchy, right? Some people are going to get more money back, some people are going to get less money back. And I think that’s a kind of a useful way of thinking about what’s going to happen in China’s property sector, right? You can think about the people who’ve bought a home as the people who are going to have the highest priority, right? So, there’s going to be a bunch of pain as the challenges in China’s real estate sector are worked out and there is going to be some pain for homeowners who see prices fall.

And there’s going to be some pain for home buyers who maybe see a significant delay before their property is delivered. But they’re going to be the people who are at the top of the list when it comes to getting paid or being protected, precisely as you say, Kaiser, because the last thing the CCP wants is for this to spill over into challenges of social instability. Who’s at the bottom of the list in terms of getting paid? Well, we’re already seeing it is the foreign bond holders, right? It’s the foreign investors who lent China’s property developers money in the dollar bond market. They’re the first people to get burned.

Jeremy: Yeah, I’ve been somebody, for so many years, have always thought that the Chinese government will stumble through whatever crisis comes its way and soon or later will kind of do the right thing, at least when it comes to economic terms, if not the advancement of human freedom. But I have to admit to feeling that in the last couple of years, and particularly this year, that I wonder if the leadership structure, the political environment has just become so completely stuck by the Xi Jinping cult that the decision-making is not quite what it used to be. And that might take some time to figure out, but what we will know relatively soon is just how bad for China’s economy this year’s COVID lockdowns have been. I don’t know if we’ll be able to attribute everything exactly to the lockdowns, but how bad do you think the damage will be to China’s economy because of the covered policies when the numbers come in at the end of this year, Tom.

Tom: We’ve already seen a bunch of it, Jeremy. Second quarter, China’s economy contracted. That’s pretty unusual. We saw it in 2020 during the first COVID wave. That’s pretty much the only time we’ve seen it during the reform era. So, there’s significant damage to China already from the COVID-zero strategy. There’s more damage to come, right? As long as you stick with COVID-zero, you are constrained to lock down entire cities, entire provinces when there’s just a few cases. We’re seeing that happening again, right now, in Hainan. There’s no reason to believe that other cities and provinces are going to be immune in the months ahead. So, it’s difficult to make a clear forecast on it, but clearly, it’s a possibility that we’ll see a repeat of what we saw in Shanghai, and Beijing, in other big cities in the months ahead with a further negative impact on growth.

Now, as China, hopefully, after the Party Congress, begins the process of exiting from COVID-zero, there’s more costs to come, right? There’s more costs to come both in terms of public health and in terms of economic impact.

Kaiser: Well, Tom, thank you so much for taking the time to speak with us. Just to remind everyone, the new edition of China: The Bubble That Never Pops will be published on August 26, so just a couple of days after this episode drops, but it is available to pre-order right now, and I highly recommend that you do so. Let’s move on now to recommendations, but first, Jeremy is going to tell you what you can do to support the work that we do with the Sinica Podcast and all the other shows in the network. Over to you, Jin Yumi xiānshēng 先生.

Jeremy: Thank you, Kaiser xiansheng. Yes, please, please, please subscribe to Access. This is our membership program, which gives you our daily email newsletter that goes out in the afternoon, New York time, every day, summarizing all the big news from China, from the Chinese media, from the Western media, and from our own sources and our own original journalists. You also get access to everything behind our paywall. And I have to tell you, for the freeloaders out there, the paywall is getting much, much tighter. So, we’re asking you for actual shackles if you want to see the goods, and it would be really great if you would subscribe to Access.

Kaiser: All right.

Jeremy: You can find details on our website. Just click the subscribe button at the top right-hand corner of the page. And the URL, thechinaproject.com is working, and that is where we will be from September the 1. September 1, all of our stuff is gonna be at thechinaproject.com.

Kaiser: All right. Okay. On to recommendations, Jeremy, you start, what do you have for us this week?

Jeremy: You know I like crime fiction.

Kaiser: You like crime.

Jeremy: I like crime. Yeah. But my father actually turned me onto this incredible series written with the pseudonym, Richard Stark. The name of the actual author is Donald E. Westlake. And he wrote, I guess, ‘70s to end of the ‘90s, early 2000s, I think. This series with a hero, an anti-hero named Parker, who is a career criminal who does mostly large-scale heists and thefts. And these books are completely immoral. There’s not a single moral person in them, but they’re amazingly compelling and really, really tight writing that is just a pleasure to read.

Kaiser: Oh, wow. You’ve sold it well. I’m definitely going to check those out. They all sound terrific. Tom, what about you? What do you have for us this week?

Tom: So, I think, probably like you guys, I read a bunch of China books, and in the last couple of years, there’s been, what I think has been a rather dreary series of China books often focused on U.S.-China relations, which arrange a kind of already publicly known set of facts and quotes into a slightly new configuration, apparently for the central purpose of allowing the author to claim that they’re a China expert and they’ve written a book on the subject. So, I wanted to recommend a couple of books, which I think do not fall into that category, and which brings something significant and new to the table in terms of the research and the reporting behind them.

The first is Surveillance State by my old Wall Street Journal colleague, Josh Chin, and his co-author, Liza Lin. Now, Hannah Arendt, the great philosopher of totalitarianism, described the process by which the German secret police tracked people they were interested in. For every person of interest, they had an index card, and they put the person of interest as a dot in the center of that card, and then they drew a concentric circle around it. And within that concentric circle were all that person’s immediate friends and family. And then they drew a second concentric circle. And into that circle, they placed all of their acquaintances and work colleagues. And Hannah Arendt said the only thing which prevents that surveillance approach from being completely all-encompassing is the size of the piece of paper. Now, of course, with social media, and with geospatial data, and with cloud computing, businesses and governments now have the capacity to do that surveillance on a much, much larger scale. And nowhere has that process been brought to a higher standard of horrifying perfection than in Xinjiang Province.

And what Josh and Liza do in Surveillance State is tell the story of what’s happening in Xinjiang, and also expand out to tell the broader story of surveillance technology and the way it’s being used by state actors elsewhere in China here in the United States. It’s a really compelling book, brilliantly reported, beautifully written. I highly recommend it.

The second recommendation I have is from an academic called Victor Shih. Victor actually makes a cameo appearance in the China debt story. It was Victor who used an innovative research technique to first draw to public attention, the extent of the problem of debt in China’s local governments.

Kaiser: Sure.

Tom: But Victor’s interests go much more broad than that. He’s also an expert in China’s elite politics. And in Coalitions of the Weak, he presents a deeply researched and revisionist history of China’s elite politics from Chairman Máo Zédōng 毛泽东 through Dèng Xiǎopíng 邓小平, Jiāng Zémín 江泽民, Hú Jǐntāo 胡锦涛, and Xi Jinping, and makes the case throwing the analysis forwards that Xi Jinping, as he moves into a third term, might adopt a coalition of the weak governing strategy, surrounding himself with relatively weak followers from rival factions who can’t challenge his position as the number one leader with negative consequences for the quality of China’s governance. So, Surveillance State by Josh Chin and Liza Lin, Coalitions of the Weak by Victor Shih, both highly recommended.

Kaiser: Yeah, both of those books are actually in my current pile and I’m planning on interviewing all the authors. I already have something scheduled with Josh and Liza, or Liza, and we’ll be reaching out to Victor really soon. All this sort of ahead of the 20th Party Congress. I’ve got a lot of work to do. Hey, thanks. Those are great recommendations.

All right. For my recommendation, I’m going to go something frivolous. It’s a show on Hulu called The Bear. It’s a great TV show. It’s about a top-flight chef who comes back to Chicago, he’s native Chicago, to run this grimy Italian beef place that his brother left to him when he died. And it’s in shambles. I mean, the finances are all completely screwed and everything is… It’s not up to code, but the food is great and it’s got a loyal clientele.

The show itself is getting its really, really rave reviews everywhere, and deservedly. It’s really compelling. It’s super-fast paced. It’s really brilliantly shot. The acting’s great. Just the gritty kind of local authenticity of Chicago. I’ve actually learned a ton from it. And plus, just watching all that cooking happening, this guy really does seem to have great chef chops.

Tom: Kaiser, I can’t decide if the contrast between your recommendation and my recommendation is making me seem like intellectual and high-minded or unbearably pompous. But I’m going to hope it’s the former.

Kaiser: Or me just being very low-brow and intolerably just kind of frivolous, right? But in any case, I think we can be all things, right? So, we can watch TV shows about chefs in Chicago and we can read books about the techno-authoritarian dystopia of Xinjiang and can contain multitudes. Anyway, Tom, thanks so much, man. It’s great to talk to you as always.

Tom: Thanks Kaiser. Thanks Jeremy. It’s been a blast.

Jeremy: Thank you, Tom. That’s always such fun and so informative to talk to you.

Kaiser: Jeremy, yeah, as always, just lots of fun.

Jeremy: Kaiser, thank you. That was a pleasure.

Kaiser: The Sinica Podcast is powered by The China Project and is a proud part of the Sinica Network. Our show is produced and edited by me, Kaiser Kuo. We would be delighted if you would drop us an email at sinica@thechinaproject.com, or just give us a rating and a review on Apple Podcasts as it really does help people discover the show. Meanwhile, follow us on Twitter or on Facebook. We’re now at @supchinanews. And be sure to check out all the shows in the Sinica Network. Thanks for listening, and we’ll see you next week. Take care.