Michael Pettis on What Evergrande Means for China’s Macro Economy

the macro pieces together. No, I don't think we've connected the dots between all of those different developments and UM and talked about their actual impact on the economy. And I mean, I don't know. To me, the big question around all of this UM, you know, what's happening in the property market right now with Evergrand, and what's been happening with the tech crackdowns and various other crackdowns. To me,

it's just the timing. You know, why decide to do all of this right after a global pandemic when you could argue that economic recovery might be relatively fragile. And again, like we're sort of seeing the impact in the property sector now, right, So China introduce this three red lines policy last year in order presumably to strengthen its real estate market. Um, and fast forward, you know a year later, it seems like that's actually caused quite a lot of tensions. Um.

So yeah, I don't know. To me, it's it's still sort of a mystery. Yeah, And there's some interesting things so like even take ever Grand for example, And obviously there are the sort of like initial effects like okay, who is going to be left holding the bag for the losses? And I think that's still TVD right, Like we don't really know how these sort of like economic losses will be distributed among creditors, among regional finance chiefs, among people who may have put down a down payment

for a home and so forth. And then there's sort of like limits of like macro impact. And you read these stories about commodities piling up in places where the home real estate development is slowing and rebar and other assets piling up, and so okay, then there's a commodity spillover, etcetera.

And you know it's interesting you mentioned like why now and of course, coming out of the two thousand and eight two thousand nine Great Financial Crisis, China was seen as like one of the demand engines of the world like these, so much of the demand was coming from China. Very different dynamic right now from a sort of global spillover standpoint where there is a lot of global demand for Chinese goods, but not a huge demand impulse it would seem coming from China itself. Yeah, so we kind

of need to have two conversations. So we need to talk about what all these recent developments actually mean for China's economy domestically, and then of course we have to have even bigger conversation about what those changes actually mean for China's role in the global economy. Absolutely, and there's one of their twists and all this, which is it's there's this global energy crisis right now and natural gas

prices are surging and China is not escaping that. In fact that China energy prices are surging in China and the sort of curbs and energy consumption, and that don't fully understand how that what's going on, or how that plays into it. Anyway, we have the perfect guest, I believe, to talk about the domestic impacts than the global ramifications. He's been on Odd Lots several times. We had to

get him back. At this moment, we're going to be speaking, of course, to Michael Pettis, finance professor Taking University and the scholar at the Carnegie Endowment, and of course the co author of the book last year, Trade Wars Are Class Wars. Professor Pettis, thank you so much for coming back on Odd Lots. My pleasure is old. Well, let's just start with I guess this sort of like I guess, I would say, the first order effects, and we'll probably

get into second and third and fourth order effects. But you know, the big news obviously, Ever, grand we don't really know how that story is going to play out, kind of like I said at the beginning, they're going to you know, we don't know how the economic losses from that implosion will be distributed. But what is your view sort of a big picture of what that means for the Chinese economy, sort of the most straightforward take

you have, Well, I'd say two things. The first thing is that I think the macro view is the is the right way to look at it. Ever, Grand d Ever, Grand Da in and of itself is uh, you know, pretty important, pretty painful, but it's much more important as a as a symptom of what we've been seeing. The latest round of defaults in China didn't start with ever Grande.

You could argue that they started in May two thousand nineteen with bao Chang Bank, and since then we've had a series of very important defaults that have all been resolved by the regulators. Um I wouldn't even say ever Grande is the most important. I think Hurong is probably the most important, and you could also argue that h n A and and perhaps uh ping On in the

future are also more important in terms of size. But what really matters about ever grand is not so much ever grand but what the property sector represents for China. I'm sure you know all the figures they've been they've been much repeated recently, but to go through them, the property sector, including upstream, upstream and downstream businesses, comprises between twenty five and thirty percent of China's GDP, probably closer to thirty than to five, and that's roughly twice what

you would expect in other countries. Real estate investment is about thirteen percent of China's GDP. So that's about one third of total investment in China, and as you know, investment in China is extraordinarily high. It's roughly of g d P. In other countries, real estate investment is a much lower share. I think in the US it's roughly five So when you look at the direct impact of a slowdown in the property sector, the numbers are pretty scary.

They're they're quite large. They represent a very significant part of the Chinese economy, and they represent perhaps thirty to forty pcent of growth and years. But there's another thing that matters a great deal, which may even matter more will see, and that is when you look at household wealth. Holmes homeownership represents roughly eighty percent of household wealth in China, and I've been trying to look at other numbers. This is more than twice what it represents in most other countries.

But I was looking at Japan during the during the bubble of the of the late nineties, and there it represented I believe roughly sixty of household wealth, which at the time was considered a really high number. In China, of course, it's much higher than that. And the reason that matters, of course, is that if you start to see a decline in the price of homes um that will very significantly impact household wealth, which in turn should

significantly impact household consumption. Is things. Yeah, I remember one of our previous guests, Travis Lundie, also mentioned that Japan bubble comparison. But okay, so here's my one big question about what's going on with China property and with ever grants.

So a lot of people are talking about some of the current stresses being caused by the three Red Lines program that China introduced last year, where it was trying to encourage a lot of real estate developers to delever their balance sheets and not to cross um certain thresholds for borrowing. I guess, on the one hand, it makes some sense for China to try to shore up and de leverage its real estate sector because, as everyone knows, it is quite heavily indebted. It is very very financialized.

But on the other hand, given real estates importance in the economy, which you, of course just described, it seems like a risky proposition to start ring fencing it at an economically sensitive time. So I guess my question is why did the authorities decide to do it. And then secondly, what impact do you think that program has had on the property sector overall. It's difficult to figure out why the timing, but but I'm not even sure that that matters.

What I would argue is that the three red lines which were announced last year are sort of the trigger for ever Grands problems, but they're not really the cause of the problems. You know, We've discussed this many times before over the past several years, and and the problem in China was that you have two types of growth in China. You have what Beijing has been calling high quality growth, which is really consumption exports and business investment

oriented towards consumption and exports. That's what I would call the sustainable growth, the real underlying growth in the economy. And then you have what I would call residual growth, which is really investment in the property sector and local government spending on infrastructure. And the purpose of that residual is to bridge the gap between the real underlying growth in China and whatever the GDP growth target is, which has always been much higher, in my opinion, at least

twice the real underlying growth. And I would say that at this point, even Shi Jin Ping, the President is starting to think this way. In a very important essay that he published in July on the New Development Model, he talked about the difference between genuine growth and fictional growth, and he said, not surprisingly, we need more genuine growth and less fictional growth. So what's the problem with the

fictional grow? Well, when you're when you're borrowing money to invest in nonproductive investment than by definition, your debt servicing needs your debt, your debt is going to rise faster than your debt servicing capacity. And this has been the

problem in China for well over a decade. And so as debt rose, in fact, the growth in debt accelerated in the growth and GDP decelerated, That created more and more of a debt problem for China, and it was just a question of time before Beijing decided to step in. They postponed it for a very, very long time, because the costs of not stepping in are in the future, and the costs of stepping in are in the presence. So it's always been easy to postpone the problem and

hope that something develops. But of course the longer you postpone it, you know the costs of both rise, but the costs of not intervening rise faster than the costs of intervening, and at some point um they were going to step in and try to constrain the growth in UM, in in in local government debt, and in the property sector. And they focus mostly on the property sector. UM So if this didn't happen this year, it would have happened

next year, or could have happened last year. I think the timing is less important then the mechanics that that that required that eventually that would happen. It definitely sounds like she J and Pag has been reading the Michael Petter's blog, because of course you've been talking for years about this idea of g d P in China, I guess, meaning something different than GDP elsewhere. And so where is in say the US or elsewhere GDP is like you

add up everyone's income. In China, they start with the GDP target, it would seem, and then they work towards them and they figure out how either through high quality growth or sort of like manufactured credit driven growth. There's a lot of things to unpeel there, and I want to get into the sort of life the prospects for the high quality growth. But one thing that came up in our episode with Travis Lundy and you mentioned it

just now, I want to hit on it. Um. You know, the importance of real estate sales or the selling of land specifically for regional government revenue. And you mentioned regional

government debt. And so if the property developers have to pull back and they start buying less land from the regional government, can you talk to us about the knock on effects and the structure of regional government finance in China and what that means if we do get for them, for those regional governments, if we do get this pull back, and is there some other structure of regional finance that may emerge in its wake. That's a very important and

very interesting and also very complicated U point. What I would argue is that in a way, it was the way this thing had to develop. Let me let me digress a bit and talk a little bit about common prosperity is you know, that's the new buzz phrase, um that everybody uses, everybody invokes to explain everything. The way common prosperity works is that Beijing has decided that in order to resolve the over the over dependence on nonproductive investment.

They have to increase the consumption share of GDP, and we've known this for many years. The first time they said this formally in public was way back in two thousand seven, but they've never been able to do it the way Common Prosperity seems to be working. As they're saying, the problem is that there is a very uneven distribution of income among Chinese households. The rich have too large a share, and the ordinary and poor have too low a share, and that's why consumption in China is so weak.

So here is what we're going to do. We're going to implement policies that transfer income or transfer wealth from the rich and perhaps from businesses to the extent that businesses have quote unquote excess profits back to ordinary Chinese and that will boost consumption in China. Now that's technically true, but there's two big problems with it. The first problem is their concept of this gets a bit technical, but tertiary distribution in Chinese jargon, there are three forms of distribution.

There is primary distribution, which is wages, salaries, income on your on your savings, et cetera. Distribution of income to households. So primary is wages and salaries. Secondary or redistribution are is fiscal transfers. And then they have this third thing which most of us would have never considered, which they call tertiary distribution, which consists of donations from the rich

to the poor. So common prosperity relies a little bit on secondary distribution on fiscal transfers, but it relies primarily on tertiary distribution donations. So why is that well, I would argue that this was in a in a sense, the problem with the dual Circulation program. The dual Circulation program, which was introduced last year, argued that that China would use its strength in exports and its strength and consumption and growing consumption to reinforce each other and to drive

manufacturing in China into the future. The problem with dual circulation is that China's exports strength and its large current account surplus. Large trade surplus is caused mainly, as it is in every country with large surpluses Japan, Germany, South Korea, etcetera. It's caused mainly by the relatively low wage share UH relative to productivity. So you're good in exports because your wages are low relative to productivity. But of course, as

you know, that's exactly why consumption is so low. So the idea that you could solve both problems was always pretty complicated. If you want to solve if you want to increase exports, you have to keep wages low relative to productivity. If you want to boost domestic consumption, you have to raise wages relative to productivity. So how do

you do that? Well, in a sense, Common Prosperity is an attempt to address that, because rather than way raise wages, which would undermine export competitiveness, you do so by forcing the rich to redistribute income to the poor in the form of donations. Now will that work there? There, As I said, two problems with it. The first problem is that donations are a tiny part of the economy. My calculation was that donations represented about three tenths I'm sorry,

three hundreds of one percent of GDP. So let's say that China is able to multiply donations by ten, which I think is going to be quite difficult. That's less than one third of one percent of g d P. And while that helps at the margin, they need to redistribute two to three percentage points of of of g d P every year to really resolve that problem. So

that's the first problem with Common Prosperity. The second problem with Common Prosperity is that they're trying to solve the American problem in China or the European problem in China.

And by that I mean, if you think that there is a bad distortion in the way income is distributed in the US, and I think there is an I'm sure you agree, then the place you resolve that is within the household income share of GDP, which comprises roughly of the U S g d P. So if you can redistribute income from rich to poor, then you are significantly resolving the income distribution problem in the United States.

But in China, household income is only fifty of g d P. The real distortion is the very high government share of g d P, which is perhaps twenty percentage points in the US and in Europe as much closer to zero, could even be negative. So what I would

argue is that Common Prosperity solves the wrong problem. There is certainly huge income inequality within China, but the real distortion and distribution is the very high share government retains of g d P. So if you want to solve that problem, what you really have to do is transfer

income from local governments to the household sector. Now, you asked about the impact of property on local government revenues, and as you know, it's a really important part of local government revenues between forty and six for you know, depending on which local government. So perhaps by by undermining the property sector, this is also part of this process of reducing the the income share local governments retain of g d P and and presumably passing it onto the

household sector. So theoretically it makes sense, but you know, the obvious the obvious concern is that that's a really difficult process to manage and that has huge political implications. So we'll see how those political implications evolved. You know. The one theme that emerges from this discussion is the idea of adjustment or trade off. You know, you try to resolve or adjust the economy now in order to

avoid bigger problems later on. But of course that kind of change ends up being um probably painful and at the very least uncomfortable. So what can China actually do? What can the authorities do to try to ease the adjustment process and avoid stirring up you know, a lot of public anger. You mentioned how much household wealth is actually tied to property, and of course we have seen some protests over losses tied to China ever grand from individuals.

So what can China do to sort of manage process? You know, Tracy the Unfortunately, I think there is there is no way to manage it. Well. The options are between bad and and and worse. You know, this is what I've been arguing for many years. The longer you postpone it, the more difficulty adjustment is going to be. And the way I think about it sort of helps me think about it is, you know, you look at the existing growth model, and you look at the various

alternatives you have to resolving this growth model. So right now, as you know, China has a growth model in which you're able to maintain high GDP growth rates only because of this explosive growth in debt. So what can China do? There are literally five paths it can take. One path is to do nothing and continue with this growth model. If you have infinite debt capacity, then that works. But I think most of us agree that you don't, and in fact, Beijing, uh seems to believe very strongly that

you don't. So what else can you do? Well, you can bring down all of this nonproductive investment. You have to if you want to stop the growth in debt. So what happens if you bring down nonproductive investment, Well, perhaps you can replace it with another source of demands.

So one source of demand could be productive investment. So switch out of you know, don't build bridges to nowhere and don't build empty apartment buildings and use that money to develop the high tech sector and productive sectors in the economy. That's much easier said than then. They've been talking about this for years and years, and later on, if you like, we can go into why. It's going to be very difficult, but at least that's one possible path.

Another possible path as you bring a nonproductive investment down is to increase the trade surplus. But of course, you know, if we were talking about Singapore, that would be viable, but for a big economy like China, that's not viable. The trade surplus would have to grow by two to three percentage points of China's GDP every year for that to be the way out, and clearly the world can't

absorb that. A third way is to bring down nonproductive investment and to increase consumption, and that requires really significant income transfers, primarily from the local government sector. And then finally, the only other path China can take is to bring down nonproductive investment and not replace it with other sources of growth, in which case GDP growth drops substantially. I would argue probably to below two to three. But that's

literally it. There are no other options. And when you think about it that way, it's very hard to figure out what is a good way, what is a good ustment process. They're all going to be quite difficult. That that's very well laid out and striking of what you characterize the sort of I guess the true rate of growth when you stirp about the non nonproductive investment spending.

You know, obviously, and we've talked about this with Dan Wong and some of China's industrial or tech ambitions, and we used to talk about it with the brad sets Are a lot before he joined the administration, and so

now we can't talk to him anymore. But obviously, like one, you know, one path is just the economy becomes much more productive and you get much more high quality growth than China becomes a bigger leader in you know, wide body airplanes and micro chips and pharmaceuticals and all kinds of things like that, and theoretically that helps balance the

economy towards something more productive. That's a long term project, though, So even if that's the type of thing that it's like, Okay, that's the path, and obviously that can't happen overnight or even next year or maybe even over the next uh

ten years. How much, though, do you sense or do you believe that Beijing is sort of like betting on that path that ultimately that it can sort of do some sort of substitution from the more speculative growth to the more high quality growth in some reasonable time framet. It depends on you know, which part of Beijing you're talking about. I think the local government politico's, the foreign affairs people, the military people, the non the non economists

think that that's the obvious way out. I think, you know, when you speak to people at the Central Bank, or or at the various regulators, or many of the economists that are a policy making advisors, I think there's much less optimism that that that that's the way out. But I would say I would say two things, you know. The first is that this is a really tough thing to do. We don't really know why. It is that some countries are very good at, you know, the very

advanced commercially sustainable advanced technology. But I would argue that success in the past doesn't necessarily equate the success in the future, because when you have highly centralized governments and a very clear target, a very clear goal, the highly centralized governments are probably better than decentralized, bottoms up type of societies and achieving those goals when you are hugely under invested in you know, you need to build lots

of bridges and subways and and and and trains and airports, etcetera. That's fine. A certain type of centralized approach may be very efficient, but when you take that next step of sustainable commercially sustainable advanced technology, it seems like you need much more of a bottoms up approach. So maybe it'll work,

maybe it will not work. We don't really know. But the other issue I would argue that we always forget is that there is a cost to following a growth model where you have an artificially boosted g d P, and I recently used the word that Gal Brave came up with with with modifications, the word bezel to represent the huge gap between wealth, real wealth and perceived wealth. And you know this gap is enormous in China. But

just think in terms of real estate. The total value of real estate in China is worth twice what it is in the US, more than twice what it is in the US, and more than three times what it is in Europe. So that means there is a perception of enormous amounts of wealth that that are probably not real. The real value if you assume the US is correctly valued, which is a pretty heroic assumption, then the real value of China his real estate should probably be between two

thirds and and and one times US real estate. So there's this huge amount of perceived wealth that doesn't really exist. And what we've seen in the past is that during the adjustment period that wealth gets amortized and those losses have to be distributed within the economy, and that causes a couple of things. First of all, it's slow, it it becomes a negative, it becomes a drag on GDP growth.

Whereas before it boosted GDP growth. And secondly, and perhaps more importantly, is that when we're all feeling richer, we tend to spend more and animal spirits tend to be brighter, brisker. But as we start getting poor, as all of that bezel or false wealth gets amortized, that changes the behavior of the economy, typically in adverse ways, which is why I would argue that every country that's experienced an investment driven growth bubble has always had a surprisingly difficult adjustment.

Now that doesn't mean that has to happen in the case of China, but unless we can figure out why that won't happen in the case of China, then I think the safest assumption is to assume that it will happen. So there's another thing that's complicating, Um what you know you just described as an already painful adjustment process, But that has to be the energy crisis that China is

currently experiencing. Um you know, there have been electricity shortages, restrictions on power consumption, and of course a similar thing is going on in Europe. So China isn't necessarily alone in facing these pressures. But again, it seems to be coming at a pretty inconvenient time when the economy is already dealing with things like everground and the slowdown in

real estate. So I guess my question is, how do you see the energy crisis um impacting the adjustment process that you described and how big a deal is it for China's overall economy. Well, it certainly doesn't help, and I think it was probably, you know, in retrospect, we probably should have seen it coming, based you know, basically

on the high school economics. One of the things that happened in China is that as the input prices in the energy sectors sword coal and oil, et cetera, the output prices didn't because they're heavily restricted, heavily constrained by

local governments. So you're only able to raise electricity prices a little bit, often by no more than ten So the power companies were in this very difficult position in which their inputs, the price of their inputs were soaring and the price of their output was pretty stable, and so they began to making very very large losses. And somehow that has to be that has to be addressed. In one way is heavily to subsidize those losses and

another way is through rationing. You you'll remember from again from high school economics, that if you don't allow prices to rations supply and demand, then supply and demands gets you know, gets matched, either in the form of shortages or in the form of excesses. And in this case, because there was no adjustment on the demand side, prices didn't go up, but a huge adjustment on the supply side where prices went up a lot, then inevitably we had to deal with it in the form of rations,

of rationing, of of of a scarcity. So the question then becomes what does China do next? And my way is I'm not very good at predicting, so what I try to figure out is what are the ways it can react. One way is to allow electricity prices to rise substantially. That will have a significant impact obviously on on manufacturing productivity and on consumption to Another way is for the government to subsidize the loss is borne by the power companies, which of course means debt continues to grow.

And then the third way is to force the power companies to eat the losses, which is really very similar to the government doing it. So there's not really a good way. If energy prices come down substantially, then that problem resolves itself. But if it doesn't, I think the most likely thing China will do is to continue effectively to subsidize energy prices to the manufacturing sector and to

two households. But remember that subsidies aren't free. Subsidies are just transfers, and the way that typically has worked in the past is that these transfers to the manufacturing sector, which is what it means when you subsidize electricity prices

are indirectly born by the household sector. So that hurts the rebalancing process, right when you subsidize the manufacturing sector at the expense of the household sector, necessarily exports will become more competitive, but domestic consumption will be weaker, So China once again has to face that trade off. The idea that you can do things that are good for both exports and domestic consumption is simply wrong. You can you have to choose one or the other, and we

know that they believe they have to choose consumption. But it's very hard to hurt the exports sector. So you know, obviously energy is a good chance to pivot to sort of a more global conversation. But there's one other dynamic I'm sort of curious your take on, and actually I don't know if you have it take on it even

but I am curious. So with with a lot of these energy and power issues that we've seen, there's an element, it seems of this sort of mobal transition to more sustainable forms of energy, and maybe certain types of cleaner energy haven't come online as fast as other types of dirtier energy have come offline, leaving us in a position where certain types of transition fuels like natural gas end

up becoming very scarce. And obviously, you know, we know in Europe they seem to take climate issues pretty seriously, and sometimes like a Davos, we get the impression that China takes climate issues very seriously and wants to come off coal as a source. But I you know, as an outsider, I never have a great sense of how much of that is very serious priority climate in Beijing versus how much is it makes for good headlines at

global events. What is your sense of the degree to which leadership in Beijing really takes that issue seriously of changing the energy mixed to something that is perceived as being cleaner and more sustainable. I think Beijing is very serious about sustainable growth and about its impact on the environment. But you know, again, I'm I'm fairly pessimistic there in the sense that I believe, and not just in China

and the US and in Europe and everywhere else. It's easier to be environmentally conscious when you're satisfied with growth. But when growth slows, it's it's it becomes much easier to push, you know, green concerns into the background. So I would argue that that's really what's going to drive environmental concerns in China and in the US and in the rest of the world. In a good economy, will resolve them, or will attempt to resolve them. In a

bad economy, will focus more on generating growth. Well, why don't we widen the discussion even more now and get even more macro and talk a little bit about out China's role in the international economy or the global economy. So maybe just to begin with, I know you've done a ton of research into this topic, and you know, have even written an entire book on this, But how would you characterize China's role in recent years and where do you see it heading given the emphasis on adjustment

that we've been talking about. Well, the way any country interacts with the rest of the world, and this is true of China, is obviously, by definition, through the balance of payments. UM. So what really matters is the extent to which China is able to reduce the gap between savings and investment. Right if savings exceed investment, China will be a net exporter of capital and will run a

trade surplus. And you know what, what we've seen in the past year or two with with the pandemic is that while the pandemic was primarily, in my opinion, demand side problem, there were definitely supply side interruptions too, but it was mostly a demand side problem, and the US, in Europe and a number of other large economies treated

it as a demand side problem. In China, the response to COVID nineteen was mostly in the form of supply side policies, so additional subsidies for manufacturing, more credit for manufacturing, which is a form of subsidy, etcetera, etcetera. Now, when that happens, you would expect that there's only two ways

that the Chinese economy can absorb the resulting imbalance. One way is through increased domestic investment, which really meant residual investment and therefore nonproductive investment, and the other way is through a growing trade surplus. And needless to say, we've seen both China's trade surplus in the last year year and a half has grown to among the highest month

lead trade surpluses we've ever seen. And at the same time, until very recently, we saw a significant increase in property development, which grew i think by seven percent last year while GDP only grew by two point three and in public sector infrastructure spending. So now the interesting question is what is the impact of the of the crisis and the

property sector. Well, that should drive down property investment. So because there is no corresponding reduction in Chinese savings, if that's the only thing that happens in China, then almost by definition, the Chinese trade surplus should grow, because of course, if investment goes down, the gap between savings and investment

will increase. That I think the Chinese are very worried about, and with good reason, because the rest of the world is unlikely to be very happy with a significant increase in the Chinese trade surplus. So there are only two other ways that that that adjustment can take place. One is through an increase in unemployment, which reduces the savings rate, but of course Beijing doesn't want to see that, So the only other resolution to that problem would be an

increase in quote unquote other investment. And the only other investment Beijing could really push is public sector local government investment in infrastructure, and already there have been a series of announcements saying that that's exactly what they're going to do.

So that's really the way I think about it. If China matches the reduction in property investment with an increase in infrastructure investment, then you really haven't solved the domestic problem, the domestic debt problem in China at all, but at least there won't be a significant balance of payments impact if they don't, if they try to constrain the growth in debt, then we should see either an increase in unemployment, which I think Beijing will do everything it can to prevent,

or an increase in the trade surplus, which I think will be difficult for the rest of the world to absorb. Does that make sense? I try to set it out really schematically. Yeah, well, so this is and you know, kind of one of the weird things about right now. And I mentioned that we're sorry to talk about the

outset in the post Great Financial Crisis environment. The sort of well not the perception of the reality is that China was this huge growth engine for the world and was driving a major contributor to the surgic commodity prices. I think the Bloomberg Commodity Index. It peaked in anyway, it's peaked again, the Bloomberg Commodity Index, and every day we're just sort of jaws dropped at the surgeon in

various commodity prices. And I've been kind of surprised, however, that it's you know, obviously this time China is not playing the same role it has And I started off with that point, and it is a Bloomberg article that I read about ever Grand and the sort of the various construction materials that were just sort of lying dormant because it's falling behind on its production of real estate

and so where it is. Previously, it seemed as though China was this sort of a major contributing positive impulse of the price of commodities. It feels like if anything this time around, that price of the surging price of commodities is a burden. Yeah, I would say what really matters is investment in the property sector is going down. I think I think we're all pretty much convinced that's

that's happening and going to continue to happen. So what really matters is that whether it's balanced by an increase in public sector infrastructure spending. If it is, we'll just see a shift in commodity demand from one sector to another, and China will continue absorbing whatever forty of the global production of of of industrial commodities. If they don't, in other words, if they really do try to constrain the growth in debt, then we will see demand for industrial

commodities go down. Eventually. That has to happen, Jo, I mean, there's no way China can continue absorbing roughly of everything that's produced. But is it going to happen now? I don't think so, because I think we're going to see uh an increase in the infrastructure spending side that will match the reduction in the property investment side. So I have one sort of big picture question in my mind.

It actually maybe goes back to the more original part of the discussion, where we're talking about different modes of growth.

It feels to me that over the course of my career, having you know, covered global markets in the economy, certain crackdowns on speculation in China happen or not that uncommon, and so you'll get, you know, for years it's like other China is doing this or that to encourage discourage the purchase of a third apartment, or they're doing this so that to crack down on online trading, and then it doesn't seem to go anywhere, and then somehow it

emerges again. And I don't know if they're toothless or if they're not in force or whatever it is, but

that is just my sort of outside perception. Is that is that accurate that this sort of this that China has made attempts in the past to sort of correct from the sort of poor growth to quality growth via that, And if so, would you say it's different this time in terms of the seriousness with which Okay, after all these years and these imbalances building up, that they're not just going to in sort of six months again be taking various measures to sort of stoke the property sector

once again to ensure that household wealth and incomes remain elevated. I think they will um and I think because of a fundamental incompatibility. So why do you why do you have surgeon debt, why do you have speculative activity, etcetera, etcetera. One argument is because you've got bad apples and you've got to identify them and throw them out of the

barrel as quickly as possible. That could be true. But the other argument is, and and it's the one obviously that I'm I'm much more comfortable with, is that there are systemic tendencies within the growth model that require all of this speculative activity, all of this bad debt, all these things that you don't want, And until you eliminate the source of that, then you're never really going to

eliminate the bad actions by the bad actors. And so what I would say is that the fundamental incompatibility is that if you allow GDP growth to be equal to the real, healthy, underlying growth what what she didn't been called genuine growth, what they used to call high quality growth, then you don't need all of this stuff to happen. You don't need the rapid expansion in debt, the rapid

expansion and the money supply, etcetera, etcetera. But as long as you have a GDP growth target that exceeds the real underlying growth in the economy, you have no choice. You have to The system has to be supported by moral hazard, because who in his right mind is going to lend into a project which has no chance of generating the debt servicing capacity needed to pay off the debt. You would only do so if you believe that you're guaranteed by either the local government or the central government.

So without moral hazard, the GDP growth target doesn't work. And so as long as you have a GDP growth target that that exceeds the real underlying growth rate, you need moral hazard in the system. And as long as you have widespread moral hazard in the system, that necessarily you're going to get all of the speculative and inefficient behavior. So you can put as many people as you like in jail. But as long as you require a GDP growth rate that exceeds the real underlying growth rate, you

will never get rid of the problem. I think that's a great spot to leave it. Michael, thank you so much for coming out an odd lot I really like the way with every question we ask, you're like, well, this could resolve in three or four ways, and there's always have clearly laid out, and I think got tied up a lot of the themes that we've been discussing in other episodes. I appreciate you coming back on Thanks show. It's the only way I can think about these things.

I take care of Michael. Thanks Michael. It is very easy for me to imagine, and again I say this is an outsider without really much perspective, it's very easy for me to imagine in three months or six months per year, we're back to like real estate records, you know, real estate prices, hitting records and China and stories about real estate mania and all of this stuff about oh finally they bite, they bit the bullet and they took this big adjustment. Is having been another another head fake? Um,

it's definitely a possibility. I mean you're sort of asking the classic is a different this time question? But I mean Michael's long running point, the more you put it off, the worse it's going to get. Right, And so I guess the question becomes is now a politically expedient time for China to be making that adjustment process. And I guess like I can kind of argue it both ways, right, So, like, on the one hand, China the economy is still recovering

from the global pandemic. But on the other hand, China has come out of it relatively resilient compared to other countries. It's also still closed off from much of the world. You know, travelers can't really go in and out. There are some pretty heavy restrictions. Um it has a huge export boom at the moment, and so like maybe that isolation and that narrative of China successfully controlling COVID, maybe that's what makes it a particularly good time to sort

of tackle some of these issues. And also, you know, tag on some sort of populous endeavors like uh, cutting education costs or having kids stopped playing so many video games. I mean, some of that makes sense. Yeah, I guess I go back and forth that you don't after speaking with Dan and Isabella, you know, it's like, oh, this

is real. And then and then when Michael lays out it's like there are no good options, right, Like, there's not like some magic bullet that's going to create good growth to substitute for low quality, speculative growth, and I go back and forth. So I don't know. I'm glad it's not my job to have to make calls and I just get to talk to people. I just go back and forth. Oh, I thought you were gonna say. I thought you're gonna say, You're glad you're not a

Chinese policymaker. But um, I guess for many reasons. Yeah, yeah, I'm glad I'm not a Chinese That also seems like gonna be stressful. All right, We're happy that we neither are we, you know, Chinese policymakers, nor do we have to make actual calls on China. But I mean I do think we are at an interesting juncture. I mean, at the risk of saying, you know, something very cliche like, it does seem to be an interesting time for the China economy and I am very, very interested to see

where it actually goes. Well, we're going to be certainly doing more episodes, I'm sure. Yeah, shall we leave it there, Let's leave it there. Okay, this has been another episode of the All Thoughts Podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Holloway, and I'm Joe wi isn't all. You can follow me on Twitter at The Stalwart. Follow our guest on Twitter, Michael Pettis. He's at Michael X Pettis. Follow our producer Laura Carlson. She's

at Laura M. Carlson. Follow the Bloomberg head of podcast, Francisco Levi at Francesca Today, and check out all of our podcasts at Bloomberg under the handle at podcasts. Thanks for listening.