TIME: 18:00-19:00, 20th June 2017
VENUE: The Henry Jackson Society, 26th Floor, Millbank Tower, 21-24 Millbank, London, SW1P 4QP
Speaker: Ann Lee
Event Chair: John Hemmings, Director of the Asia Studies Centre, The Henry Jackson Society
Ann Lee: Thank you John for that warm welcome and thank you all for coming today I am really delighted to be here. I was really a bit surprised by the warm weather here in London, I thought only New York had this kind of weather in the summer. I would like to say I am quite aware there has been a lot of negative perceptions of China’s economy, you see it in the media constantly and I acknowledge a number of their assertions of why they are so negative, clearly a lot of people point to China’s increasing debt loads and it is growing very rapidly and their slowing growth rates. People also point to the fact that there are also growing labour forces going to be shrinking and that it may look like Japan.
So there are a lot of reasons to be negative about China but I more or less say in my book that while there are challenges I actually don’t see any of them as being existential threats causing a collapse in their economy. So I am going to begin by using an analogy on how I would like to frame my argument because I think that countries are like people where you go through phases and so like a person you go through a childhood phase and I will say that modern China beginning after the civil war took part with the nationalists that period until about the time China entered the WTO I would characterise as China’s childhood phase. That is a period where a lot of the policy makers and leaders of China really didn’t have a great deal of experience governing this country and especially in a communist manner, recall that before this China was basically an Empire with Emperors and then they had a short stint trying to turn it into Republic but that failed miserably it didn’t really last. It was more or less a semi-colonial state when a lot of Western power took power over major chunks of it so the Chinese didn’t have a lot of governing experience to run a robust economy here. There was a great deal of inflation going on in China in the double digits and the effects of this led to events like Tiananmen Square which was a rather low point. So we can see that China made a great deal of mistakes, stumbled many times but they learned a lot. As a child would make a lot of mistakes so did China’s leaders here.
From the time of WTO to about now I would say that China has entered its teenage years phase in which China’s economy quickly shot up and grew very fast much like a teenager does and it’s still learning it is still interacting with the world more but it is increasingly taking on more responsibilities, becoming more sophisticated in the economic tools they are using and I would say today that China is more like a late stage teenager in which it is looking more and more like and adult, behaving more like an adult, taking more and more leadership responsibilities in the world and you know is not quite there yet but is basically behaving more and more like what we would expect like a true adult country, so to speak.
So I would say this is the sort of period where we find China and not to say that young adults can’t get into trouble and die from gang fights or doing illicit drugs or doing something that is against its own interests and so China can easily make major mistakes in that sense and suddenly not be in a healthy position. Short of China doing something drastically extreme in that sense which I kind of define in my book as maybe getting into military engagement against the US not something which they should be doing at this point in time then they should be ok. The economy itself is rather diversifying now, the monetary authorities have learned quite a bit from sending their policy makers around the world to learn best practices and so they have studied a lot of other economies and studied what other countries did in terms of mistakes and how they succeeded in different areas and I think they are capable of steering through a lot of challenges as long as again they don’t do something extremely stupid.
So why am I optimistic here about China? Well for one when people say that China is just like Japan I would say that yes there are similarities but then there are major differences and here I will highlight what I think the major differences are. One China is a much larger economy than Japan. Japan is absolutely dependent on exports, as a small Island it cannot survive without a strong export component to their economy and it remains so. It is a virtual one way street where everything is exported out of Japan and they import very little. China on the other hand its exports have already dropped by half but I think even if it drops more it has a very strong domestic internal economy that can keep it going. There is more than enough in terms of domestic demand in their population to keep the engine going, remember there population is over 3 times as large as the United States so that is a major difference here.
Another is that at the time when Japan sort of blew up and had there lost decades, Japans assets were much more inflated than where China’s assets are today. It was many, many time higher. So that fall was much more extreme. China’s leaders are aware of this and I think they certainly keep the lid whenever things get a little too hot, they tighten monetary policies very quickly, they are quite proactive that way which leads me to my third point. A lot of the Japanese policy makers then were often in denial when you look at history and when you speak to a lot of Japanese authorities they will admit that the Japanese policy makers really didn’t want to acknowledge their problems, they didn’t aggressively do anything when there stock markets crashed and all their assets basically had an implosion. This is what kind of led to the zombie state whereas China their policy makers are very proactive. They will be the first to admit what their Achilles heels are and they send their policy makers to work on things long before it becomes a problem.
So even today say with their shadow banking system which people criticise, you know they have definitely made lots of headway in trying to clamp down on their banks in terms of exposure to different trust products or wealth management products. Certainly the one major thing here is we have to recognise China’s debt. As troubling as it may seem to some is largely internal domestic debt and the composition of debt matters a great deal in terms of how well a country will fare. So if you look at countries like Greece right and they have a debt issue, it is because they are borrowing in a currency that they don’t have complete sovereign control over. Right they are borrowing in the Euro and the Euro is controlled by the ECB which is a joint thing they have to negotiate with the Germans and many parties in order to reschedule their debt payments or to extinguish them. So they don’t have that freedom to sort of wipe the slate clean if they wanted to whereas countries that basically have debt in their own currency such as Japan, they have debts which are many times higher than Greece’s and yet they are not in trouble. Right nobody is saying that Japan is collapsing, I mean they are kind of just puddling along but the fact that their debt is over 600% GDP and is not causing people concern is because their government can deal with it in ways that is not necessarily going to trigger any loss of confidence so to speak.
I would say that China has the same situation almost all their entire debt increases largely based in the R&B and we have to remember that for those of you who are in finance and for those of you who are not in finance, financial systems are basically manmade structures, people invented the financial system, people come up with the rules it is not something which is hard and fast like physics or chemistry or any of the hard sciences where certain things are set in stone and there always true. Not true for financial systems they reflect in large part the culture of a society, the priorities of the folks who are making the decisions on how the financial systems should work. Just to make an easy comparison Canada’s financial system is far more stable than what we have seen in the US. Canada has had hardly any financial crisis ever, they have a very different regulatory environment, much more conservative ways of running their monetary policies and the financial system whereas the US financial system tends to be prone to recurring crisis almost every few years.
So I would say that this also applies to China their policy makers have studied what happened with the 2008 financial crisis very, very closely, they are very determined not to create anything that looks remotely similar to the US and so I would say that their financial system would probably look more like Canada’s but if I had to make more of a pure analogy of what I think they are trying to create is what Alexander Hamilton did back in the founding father days of the US when he was trying to create central bank he said that it was purely for nation building purposes, that it is not used for speculation, it is merely to provide capital so that infrastructure and nation building activities can be conducted. I see that happening with China’s policy makers and spades they have used their capital to pretty much build out the entire infrastructure of the country very rapidly and now they intend to use that same capital to build out infrastructure in many other parts of the world among developing nations that sorely need infrastructure but don’t have the capital, the expertise or the skillset to do it.
As we see how China uses its currency it is for these purposes we don’t really see China pushing their financial system on the rest of the world at this point. What is traded outside of China is minimal at best in terms of R&D bonds or stocks they are virtually non-existent. So we see a very different kind of financial system developing in China and so I would say that given the situation I don’t think China’s financial system is prone to the same kind of crisis which we identify with here in the West and a lot of people who make that argument in the West tend to be folks who work at Think-Tanks or academics, they have never worked on the real world on Wall Street to understand how these mechanisms work. Other folks like Gordon Chang who wrote the collapse of China back in 2001 clearly has been wrong and he was a lawyer. So he may make a good argument but again he doesn’t understand the mechanics of how these financial systems work. So maybe I should just stop there and take questions from yourself and the audience.
John Hemmings: Absolutely, why don’t we give you a quick round of applause. I hope the audience doesn’t mind I will take the first stab and then I will happily turn it over to Q+A and if we can keep your question to under 3 minutes that would be great since we have quite a full room and limited time. So I will try to limit my own questions. My favourite kind of China watcher would be Mike Pettis who you may know from Beijing University who seems to try to address this question as well. He does also trace the similarity I suppose between what you would call the credit SOE model and I wonder if you could drill down a little bit into what you said about the growth of China’s consumer economy as one point and then maybe because I’m being cheeky I will ask you if you can also drill down into a bit more about the R&D and because we are in London, the city is just around the corner, some of you maybe even involved in the business what are the chances of the internationalisation of the RMB? Not internationalisation but becoming a reserved currency how would that happen and do you see London playing a role in that? Is the golden era still on?
Ann Lee: Sure so I will take your second one first. China’s already got a reserve currency so the IMF admitted the R&D into its SDR reserve basket last October I think, it happened already. So they basically formally said that yes we will recognise it amongst the central bankers that this is a reserve currency. I think that as far as what that means in the short-medium term I don’t think it is going to change much in terms of seeing China’s currency being traded more frequently or more widely in financial markets. Largely because, one China basically understands that the vast majority of currency transactions happens still with the US dollar which is the dominate reserve currency.
So if there were a currency war and they can take all kinds of forms, but we have seen what happened with George Soros going against the Bank of England or what was going on with the Euro crisis. A lot of times these speculative attacks have nothing to do with free markets per-say it is actually just a small number of individuals who decide to take on a lot of leverage to pursue a certain outcome so they can benefit and profit from them to the detriment of entire societies. Basically China knows that even with their 3 trillion plus reserves that they hold in US dollars that’s still frankly not enough to go against any speculative attack from Western speculators that have infinite actors to money. Infinite vs trillions there is no match there.
I think they will continue to erect currency controls as long as the world still is being dominated by the US financial system and using the US dollar for the vast majority of the transactions. Were China’s reserve status will come into play is when if there is a problem like what happened with Lehman or whatever and central banks need certain currencies then China is more than happy to provide R&D or other currencies like the dollar whether for practical purposes in terms of allowing nations to meet whatever short term shortages there are so that they can avoid monetary squeezes but they don’t want to allow themselves to be a victim of speculators who have mal-intent in terms of playing currency wars with them.
So from that standpoint I don’t see China’s reserve currency being freely traded it will be freely available to central bankers but that’s kind of a different thing and they will make it freely available for normal trade which is what most companies engage in. They are not going to allow it to be freely available for capital speculation.
John Hemmings: We can address the Michael Peddist one later I will turn it over so we can get the full mutiny. If you could just say your full name and affiliation, we will start with this gentleman here.
Question 1: My name is John Pickup and my company is Abington Systems and I have worked with Chinese people for about 15 years. I have got to say Professor Lee I think you are incredibly brave to live in the States and have such a balanced view of China because my friends and I went to MIT, of course you went to Harvard so I have got to defer to your position they have a knee-jerk reaction that everything going wrong in America is the fault of China which we all know is rubbish of course but you are in that environment and have a balanced view. Can I ask you therefore to do something difficult and forecast the future? Using the analogy of teenagers I think China is now approaching around 30 which at age 30 is about the peak, they have got the biggest 4G network in the world, they have just announced last week the 5G network which is fundamental to research and communication and everything, they have the fastest computes in the world, they are driving Nano technology but the key thing was the AIIB was it two years ago when they launched that. Despite everything that America threw at it we the Brits put our hands up and said we will sign up for it. So using the analogy China in the next 5 years is entering the years of 30s which is the real dramatic growth of the Chinese economy and the influence in the world.
Ann Lee: Well yes I guess I agree with you that China’s investing a great deal of R&D into a lot of areas and in some areas I think they have even surpassed the US even if the US would never admit to that in terms of a lot of green technologies, China spends more than twice that of the US in alternative green technology right now. This is a figure that came out of the hundred bowl foundation which is a German think tank.
I would say that China is still not an adult yet just because they still have hundreds of millions of people living in utter poverty still in Western China, they are still trying to upgrade their standards of living and this will take decades still and I don’t see the US relinquishing their leadership role anytime soon for China to step into a leadership vacuum so to speak. I don’t think the US is ready to do that emotionally, politically, economically the US I think has created a lot of anti-China rhetoric because they are fearful of China eclipsing them at some point and that’s why they will in some circles say that they are trying to provoke China with various things. They always have accused China of currency manipulation and all sorts of other things but I would even say some of the geopolitical tensions from the South China seas to the East China seas and what is going on in the Asia pacific, it is extremely curious how all these tensions sort of erupted out of nowhere when all these issues have been there for decades.
I would say that back in 2012 I had a private lunch with the central banker of the Japanese central bank and he told me oh we get along so well we the Japanese are working with the Chinese and the South Koreans are trying to create an Asian currency like the Euro because all there supply chain networks are so intertwined and so they would prefer to not have to exchange in these transaction costs and use the US dollar when the US is not involved in any of their transactions. I believe that yes the US got wind of this and decided that they needed to reinsert themselves into the Asia pacific because if there was too much peace in Asia then there would be no reason for the US military to exist and they needed a reason to be there.
I know what I say is very counter conventional and you are not going to hear it from anybody else. I happen to have lots of private conversations with people in Japan, with people from the Obama administration, diplomats to the ASEAN region and they all tell me these things the dirty games that get played in Washington in order to ensure that the US remains the world’s super power and that it is a pax-Americana for the foreseeable future. So as long as that is happening I cannot see China taking that adult role yet.
John Hemmings: So let’s take two questions together.
Question 2: Anna from Lloyds Bank. I wouldn’t disagree with a lot of what you are saying in terms of the analysis that there isn’t a sudden collapse coming and the economy is in vast as you said even now in early stages of development so there is a lot to be achieved. The issue I think with most people is that they don’t think it is going to collapse but any sort of slowdown in China from the levels we have been seeing or the rates we have been seeing has not only a big impact on China but a big impact globally. So that is where the concerns are and that is where the sort of markets get frightened and I think the issue is yes it is an internal problem I agree, foreign debt is minimal and China has lots of internal assets but obviously if there is a sort of debt crisis as such that they will slow down internally. The comparison with Japan is interesting as that price was paid when Japan was at quite a really advanced stage of development, you know this is much earlier so it is just to make that point but also looking into the future will China fall into the middle income trap and not go beyond a certain level of development?
Question 3: I’m Bill from the University of Bath, I’m persuaded by your case that China is neither a threat nor destabilising necessarily to the world economy. I was wondering whether you feel able to comment on other elements such as social and cultural forces inside contemporary China. When I talk to the Principals there that I engage with their number one concern is the younger generation. They have absolutely no idea what they think, what their values are, what they get up to in the evening, what they are doing on their gadgets. I was curious to see whether you feel able to comment on that kind of element being destabilising and subsequently impacting the inaudible..
Ann Lee: Absolutely thank you for those questions. So regarding China’s slowdown as a concern I would say that in terms of actual dollars in growth so not talking about percentages, yes percentage wise they have slowed down but if we are talking about actual dollars actually it has not slowed down at all. China is growing at about a Russia every single year, that is how big there economy is and the growth like creating a new Russia each year is a lot of economic activity going on. If we had to put it in say 2005 terms there growth rate right now is about the equivalent of 17% so it is actually extremely high. So this slowdown that people keep saying in terms of economic activity it is not slow because China’s economy is the foundation, the basis, so much larger now than it was when it was growing in the double digits so the fact that they are still growing at over 6% with such a large economy and from a purchasing power standpoint the IMF has said it has already surpassed the US so imagine an economy that is bigger than the US, growing at over 6%, that is hardly a slowdown that is massive growth. So I am actually not concerned about a slowdown I think it is not truly characterising it fairly.
The middle income trap so I would be concerned if the Chinese government were not investing in R&D and you know trying to invest in the future but they are doing it in spades. They announced their 5 year plans every year with very hard targets where they would say we want to reduce carbon emissions by 21% over the next 5 years or whatever it is they have hard targets for just about everything right. The way they do it is just pushing money into lots of R&D areas so there is research going into bio-technology in fact I have a friend she is a nuero-biologist at Scripts College in San Diageo and she sent me an email saying I just can’t believe like I wish the US NIH would at least even spend half of what China does giving out research grants in doing breakthrough research in brain cells and stem cells and that sort of thing. China’s government is really sort of behind that.
So I think that that middle income trap is not going to happen as long as they drive a lot of incentives for people to go into these areas and then they will create innovation which can create more jobs down the road and this will allow them to innovate into higher paying jobs and higher paying industries and it is already happening. I speak to venture capitalists in Silicon Valley in fact they all go to China looking for deals because so much of their technology is surpassed. So I don’t see that as a real danger as long as the Chinese policy makers have their eye on the ball that way.
Regards to the cultural situation, yes I think that these kids are definitely not that politically orientated they are acting like all other kind of kids around the world basically enjoying a very material life. Whenever I go to China these kids are out spending their money going to Justin Bieber, Beyoncé, rock concerts and a lot of movie theatres have American Hollywood movies playing they are in there in droves. All the restaurants are packed with young people eating and dining and drinking so it is very materialistic. But they are also I guess not different to many other millennials around the world they do spend a great deal of time on their smartphones, they do almost all of their retail purchases through their smartphones now they don’t even carry credit cards it is all done through AliPay. They have a can-do attitude they feel like wow we can create new companies, new start-ups and they can get rich. So their mentality for the most part is very similar to what you find in Silicon Valley.
So I think if you spend any time in China, especially Beijing or Shanghai I think you will notice that there is a real energy in the air when you go to other places. I felt it because when I spent a year teaching at the Peking University in Beijing when I came back to New York I actually felt depressed for a while because New York felt like a morgue to me, everything moved so slowly in comparison. So I think that when these kids feel like they can have some control over their futures and a lot of them go from job to job very quickly because they get offered major salary increases all the time I think that they are going to be pretty content that way and not very politically motivated.
Question 4: Inaudible… both declared the Chinese economic model unbalanced, uncoordinated and unsustainable and inaudible… has said in terms of reform and if there is no successful inaudible… then reform won’t happen so what in your view constitutes successful reform and how far inaudible… since the third plea is China advanced inaudible….
Question 5: I pretty much agree with you that it is hard to see a trigger for a financial crisis that would bring everything down. I also agree with you that if they can continue to grow at 6/7% that is still a huge contribution to the world economy. My concern though is that they are about to slow down to 1, 2 or 3% and the reason I am concerned about that is from what I can see the overinvestment in the economy alongside the very high levels of inaudible… debt. If you think about what they have done over the past 3 or 4 years it seems as though they have pulled every lever they can to keep economic growth going, they boosted the housing market, inaudible… heavy industry of course there is massive over-capacity they have cut interest rates at times but that is going to be more difficult going forwards. We know that on the fiscal side the fiscal deficit has increased substantially on some of the IMFs definitions its 8-10% of GDP it you take on wider vision of it. So it seems to me they are running out of levers to check out the economy the next time it slows down so my concern is that next time there just won’t be anything they can do and the economy will slide at a 2-3% growth rate, investment will generally slow down and there will be a confidence crisis if you like that might show up in the financial sector as well and then suddenly we will be living with China growing at 2-3%.
Ann Lee: Great thank you for those questions. So regarding the SOEs I would say that that is a reform area that has not had a lot of movement mostly because 1 there is a lot of political resistance to it but 2 I think the folks who have thought about well, what is the real objective here where not here to necessarily maximise profits we basically want to keep people employed. They have a very different view of how they want to run a society, they think it is a much kinder way people would want to keep on working rather than taking welfare cheques. They are attempting to deal with the industrial SOEs by the whole Silk Road project right so if they are successful in pushing this equivalent to a marshal plan then they can put a lot of these industrial manufacturing plants to work and reduce that overhang of excess capacity because you are going to be building many China’s around the world with the infrastructure bill with what these countries need. They are already making a great deal of progress going across the central Asia region. They’ve got at least 40 rail lines right now going basically from China going all the way to Europe and I don’t see this slowly down. Also they plan to do this in Africa and Latin America so you can imagine if they get to do all this you’re not going to have excess capacity in steel and all these things. So I think that is how they plan to address that SOE issue.
Regarding Chinas slowdown of course it makes sense that they are going to slow down eventually because it is just the law of large numbers I mean they are going to have a much bigger base and unless you can create more demand from these developing countries, you don’t have demand from the rest of the world to want to absorb all these different products and services people are just up to their ears with stuff so yeah you can’t grow it higher it is just impossible. Not to mention the fact that with Chinas labour force shrinking because even though China has basically removed the one child policy they cant seem to get their population to have higher birth rates right now so they are suffering from the same issue that developed countries have so eventually we are going to have a shrinking population – do you need to have really high growth rates if your population is shrinking, probably not so I don’t think that will pose a long-term problem for China. It may cause alarm for other countries because other countries would like China to continue growing very fast to pull everyone else’s economy along but from China’s own standpoint I don’t think they see that as problematic given what is happening over there now.
Question 6: It seemed to me that when I lived in China that it was a very vibrant society it had the most massive building program, the educational system was simply first class and the people seemed to be really determined to advance their own society. Whilst I except that economies can move, slow down and start up again, it didn’t seem to me that it was an economy that could be collapsing simply because the kind of people that the Chinese are. I just wondered if this building program that did really end rather quickly was a size benefit.
Question 7: Thank you for your talk which was really quite optimistic about the future of China. If you look outside the economic inaudible.. you said one of the reasons was that you didn’t expect China to do anything extremely stupid. What of course could happen is we have a new US President in Donald Trump who is an impulsive, unpredictable, and irrational and we don’t know what is going to happen. One of the worrying things about Donald Trump is before the election he said I love conflict, I love war, you have someone who is utterly different to any other US President that we have had in the last 60 or 70 years. Could Donald Trump, could the US have a catastrophe where they nuke North Korea, nuke Iran which would have terrible worldwide consequences? This is the man who has been totally underestimated by everyone, I remember talking to someone before the election about Cuba and I said is Donald Trump going to dismantle the agreements with Cuba, oh no he would never do that, the man deals with the Cuban government they have got so much going for it and then in the last few weeks we have seen all the hard work gone back 50 years. With Donald Trump we don’t know what is going to happen do we.
Ann Lee: So regarding Chinese culture and why they suddenly stopped building so much. I would say that China is very built out at this point people have complained saying that they have ghost cities everywhere so China doesn’t need to build more because they have already created enough property to absorb a lot of the migrants frankly. So China is basically saying we have an expertise in infrastructure we are happy to help other countries who need help with the infrastructure do it so we will redirect our building activities outside of China not within China.
Regarding Donald Trump and whether China will do something stupid, some observers have already said they are quite surprised China hasn’t taken the bait on anything because clearly taking a phone call from Taiwan and doing other things to provoke China, upset them. China has been pretty much I guess even-keel though all this, we haven’t really seen any military conflict erupt out of all the possible tension points right. I think that Donald Trump’s administration can do more provoking and it’s not probably going to move that needle. I think the only thing that will do something is if the US decides to attack China then of course they will defend themselves.
When I look at or watch various lectures coming out of CSIS with is a military think tank in Washington, I think these people are continually changing their tune about how they asses Chinas military capabilities. I think a few years ago they would basically say that they think they could win a war against China hands down, today I think they are more hedging their bets because they are not as sure on what China’s capabilities are and I think that is exactly what China wants to do. Their playing sort of the same game that President Raegan did with the Soviet Union which is to make the other side think that they cannot win a war and that’s the deterrence. So as long as the US isn’t sure then they are not going to act. Then you keep the peace that way.
John Hemmings: On that I know some people are trying to get home so what we will do we are going to finish now but I think you might have a few minutes afterwards for chatting with people, so if you didn’t get your question I do apologise to you I just know that some people will want to struggle home and get their dinners in. But I do think that was an extremely back and forth, it is a challenging issue that I think we will continue to strive to predict, to understand, in the coming years and we certainly thank you for your contribution today to giving us a certain stab in the right direction so thank you very much.