Economists James Henry and Ho-fung Hung warn that China’s debt-to-GDP ratio above 240% is an indicator that there is a major disconnect between the market and the real economy. The following is a transcript of an interview with the two economists on the Real News Network.
SHARMINI PERIES, EXEC. PRODUCER, TRNN: Welcome to the Real News Network. I’m Sharmini Peries coming to you from Baltimore.
Chinese markets have been turbulent since the start of 2016 for several reasons. Days of stock exchange suspensions, the lower yuan against the dollar, the weak factory service sector surveys, and of course worries about looming share sales by major stakeholders once a ban on such sales expires. These are all creating havoc in the market, and with the 7 percent circuit breaker deactivated late on Thursday, two of China’s stock exchanges closed at 2 percent higher on Friday than it had been doing all week. Let’s figure out what happened, its implications for the global markets, and what to expect moving forward.
For that I’m joined by Ho-Fung Hung. He is the author of China Boom: Why China Will Not Rule the World. And we are joined also by economist and attorney James Henry. Thank you both for joining us.
So, Ho-Fung, let me begin with you. What is it exactly that the Chinese government is trying to regulate and discipline here when it comes to the market?
HO-FUNG HUNG: Ups and downs are very normal in the Chinese market. It’s like a roller coaster in the last years. And after the Chinese market dropped two times over 7 percent and triggered the circuit breaker, and then the government saying that they are suspending the circuit breaker mechanism, and the market went back up on Friday, reportedly. And there’s a lot of, of course, unverified rumors that–or expectations that China’s government actually has more [inaud.] to prop up the market that they have been doing quite a lot of times in the past.
So when they say that, when they said that they are going to stop the circuit breaker mechanism, I already expect that the market will go back up. Because the government will look very bad if they suspend a circuit breaker, and then it drop, like, more than 7 percent or like 10 percent, and the government will look very bad. So the government will do everything they can to stop this from happening. So I won’t be surprised if the government actually move in some of the money to prop up the market on Friday.
And of course people are speculating what the government is doing, not only about the stock market but also the rapid devaluation of the currency. The reason why people are asking this question, what the government is doing, what it is trying to achieve, is mostly based on the assumption that, an assumption that has been held for a long time, that the Chinese government always know very clearly what it wants to do, always knows what it wants to achieve, and it always has some grand, strategic vision behind all actions.
So it is kind of a long-held assumption. But you look at how the Chinese government behaves in response to this market turmoil, from the [inaud.] allow that the credibility of the Chinese government has been put in question. And maybe it, maybe it is time for us to allow, to scrap the assumption that the Chinese government always knows what it wants to achieve, or what it wants to do. And you look at the circuit breaker, it introduced a circuit breaker, and it, after four days, after it becomes so chaotic. And you look at the currency as well in August, when the renminbi devaluated [big time], the Chinese official coming on and saying that it is a one-time devaluation. It’s not going to continue to come down, the market.
And in September, if you still remember that when Xi Jinping visited the U.S., and in the joint press conference with Obama that he made the statement very clear, that the renminbi has no basis for further big devaluation. So it seems that the government is giving confidence, was giving confidence to people that the renminbi is not going to devaluate. But yet in December, by the end of the year and in the beginning of the new year, that you see the renminbi devaluate sharply, more rapid than in the summer. And of course it now came back, a little bit like–and now it seems that, and also last week there, this week there was data released about the Chinese government that the Chinese foreign exchange reserve has been dropping very rapidly in December. And as in the whole year, basically, pretty much since the middle of 2014.
So it seems that the government was in a kind of a panic mode. There was capital flight going on. We don’t know the exact schedule, because China still has capital control, and people are trying to get around this capital control to move the money out. But at the same time, the Chinese government is trying very hard to [burn] its foreign exchange reserve to support the currency. So now the Chinese government seems to be in a dilemma that is between whether to let the renminbi continue to devaluate or to continue to burn its foreign exchange reserve to support the currency. And then we already see a lot of reports here and there from within China that, like, banks are restricting amount of foreign currency that we tell individual savers can get. And then some people who want to change their money into foreign currency, like Hong Kong dollar, U.S. dollar, find it very increasingly difficult to do so.
So it seems like the government is doing a lot of things to try to stem the capital flight.
PERIES: James, to you. What is it that the Chinese government is trying to do here? Obviously it’s to discipline the market in one way or another. But for what purpose?
JAMES HENRY: Well, let’s talk a little bit about what’s going on fundamentally. The reason this set of episodes that the professor described is having an impact on world markets is that when the Chinese currency plummets, people around the world are concerned about a contagion of competitive devaluations. So not only has the economy in China been slowing down, but–which affects major development countries like Brazil and South Africa that have become very heavily dependent on Chinese exports to China, but it also threatens to set off a round of devaluations by Chinese competitors, like Indonesia or Japan. And so that’s why this went from just being a crisis on one stock market, which we know has been a casino, to a global phenomenon.
China has a difficult policy problem on its hands. It is trying to so-called rebalance its economy, shift toward more reliance on consumers and household spending, which is only about 40-45 percent of GDP, and to raise household incomes. At the same time, it needs to worry about its massive debt, as a fraction of GDP is about 200 percent. So a lot of people who are not that savvy about China, don’t watch it every day, were called all of a sudden to wake up. It’s like the big short in 2007, when suddenly people woke up and said, hey, let’s take a look at those subprime mortgages. Are they real? And people are now invited to take a much closer look at China, at where all the debt that’s been financing its growth have grown, has gone. A lot of state-owned companies have done a lot of spending and may be insolvent, technically.
So this is a wakeup call for the world economy. And you know, it’s far beyond this one set of technical mistakes that China may have made with this devaluation.
PERIES: All right. Ho-Fung,what do you think the government is trying to achieve in the sense of these regulations? You know, the 7 percent circuit breaker regulation, limiting the actual market activity by who can buy and sell, these constraints were introduced for what purpose?
HUNG: The government has been trying very hard to stabilize the market. Starting in late 2014 and Spring 2015, when the Chinese stock market was starting to soar, when the bubble was going up, then the Chinese government or many state enterprises invested in China are trying to ride on the bubble and fan the bubble, and fill the bubble. And many Chinese state-owned enterprises heavily indebted, as James just said. A number of the big enterprises in China is heavy in debt. They’re trying to sell their own stocks to pay some of their debt.
So at that time, when the bubble was rising, that the Chinese government and many people in China really want to use the stock market to help solve the debt problem. At least, reduce the scale of the problem. But after the collapse of the market it actually, it backfired. Many enterprises became more heavily indebted because of–. [Inaud.]
PERIES: James, comment on that. The GDP-debt ratio in China is huge, you were saying offline it’s at 200 percent. Why is this so, and what are the measures to get it under control?
HENRY: Well, that has been what’s been financing the extraordinary growth rates that China has sustained. But at some point the debt level now exceeds–you know, some people are saying 250 percent of their GDP, because some of the debt is not accounted for in the so-called total social financing. But it’s at least 200 percent of GDP.
And that is a concern mainly from the standpoint of–you know, there are countries that have had higher debt levels than that without going into a crisis. But you know, it’s a concern because if China can’t figure out a way to grow without more borrowing, then eventually the debt level goes to 300 percent of GDP. At some point you have a serious debt crisis. So that is the longer-run problem that’s been ignored by everybody who’s been speculating in the Chinese market. And just–you know, the fact that the stock market rose 135 percent between June 2014 and June 2015, and then has crashed by 50 percent in the last six months, is just an indicator of how disconnected the stock market in China is from what’s going on in the real Chinese economy.
So I think what–you’re absolutely right that the Chinese policymakers are trying to get a hold, first of all, over the instability and volatility of the markets. Secondly, to curtail capital flight. And thirdly to figure out, you know, how they can cut interest rates, stimulate the domestic economy, have a $585 billion stimulus package to maintain or accelerate growth, which is declining, and at the same time not have a, have their currency freed up so that, without having it plummet.
PERIES: Let’s take up this issue of stimulating internal growth in the economy. How are they going to do that with their wages being so low? Let me go to you, Ho-Fung, for that.
HUNG: I guess it is quite difficult to stimulate the economy right now. The priority of the government is to save the economy from falling further. And as James said, their debt to GDP ratio is very high, 200 percent, at some estimates 250. And it’s still growing. In 2015, the debt growth is about 13 percent, according to some conservative estimation. And the GDP, if we believe in the government figures, it is just 7 percent. So the debt is growing still faster than the economy. So the debt to GDP ratio is going to grow.
And when it gets out of hand, there only can be two possible endgames of it. One is that many of the enterprises become heavily indebted, cannot pay back their debt, and then they default. And then it will eventually bring damage to the financial system and there will be more unemployment and lower consumption because of the unemployment. And another possibility is that the government use these fiscal resources to build out and save many of these companies from bankruptcy. But in such case, then the fiscal position of the central [inaud.] and also that many of these saved, bailed out companies will become kind of zombie companies that has been haunting, like Japan’s economy, for a while, and then China will be in the longer time of more slow growth.
So I think at this time the government, it doesn’t have the luxury to talk about pushing up the economy to a radical mode, or a mode–but basically to prevent [inaud.] disaster to materialize.
PERIES: Now, James, one of the conflicts the ruling class here has is that they are very involved in this market, and they’re trading in this market, and government corporations are also in this market. So it’s hard to regulate it against itself, isn’t it?
HENRY: It’s a challenge. I think, you know, we don’t–I mean, China’s not unique in that situation. We also have an elite that has a hard time regulating itself with respect to the banks and politicians.
So I want to emphasize here that China is a major strategic partner for the United States. Nobody should take any joy in the difficulties that China is having. And what we really need to figure out is ways to help China get through this problem, because they are so important to developing countries all over the world. And there’s a, you know, it’s a critical investor in the United States, of course, as well, and a critical trading partner. And so, you know, there are many things we can all think about doing with respect to, let’s say, a global stock market, and why is it overreacting to events in China on such a massive scale? You know, that’s not helping anybody. And how can we, how can we collaborate on having reasonable exchange rates here across borders, that don’t end up in a race to the bottom, competitive devaluations. That would be a nightmare.
So you know, the United States has a positive interest in making sure that China is able to stabilize and return to prosperity here.
PERIES: And Ho-Fung, is there any internal rebellion going on? I know the workers survey is also impacting on the market, and are there workers speaking out, organizing, rebelling against this?
HUNG: The reports showing that there’s an increase and hike in labor unrest in China, that is, actually, this trend has been going on for a long time. There’s all these wildcat strikes, because–and also particularly some exporters got bankrupt and they have failed to pay their, the laid off workers that suddenly find that their employers are gone.
So there’s a lot of this kind of unrest. And the authorities definitely are very worried about it. So it is why you see the report that authorities starting to cracking down on some politically harmless and labor NGOs people, arresting them that has been regarded as safe and not threatening to the regime for a long time. But suddenly the authority becomes very concerned about it. So the government is definitely worried about it, and it is definitely, this economic situation in the long run is going to fan more unrest. But at the, at the time being, authorities seem to resort to more oppressive approach to prevent this economic turmoil from spreading to become a kind of a major sociopolitical upheaval.
PERIES: Ho-Fung Hung and James Henry, thank you both for joining us today.