Stig Brodersen  01:08

So Leland, today, we will together take the helicopter view of the Chinese economy and the relationship between China and the trading partners, including the US, of course. Now, it’s hard not to talk about the Chinese yuan when we talk about the Chinese economy. Back in August, one US dollar was worth seven yuan (1 USD = 7CNY), and the depreciation of the Chinese yuan happened very rapidly. Could you talk to us about what happened then? And how would you describe the impact of the Chinese economy?

Leland Miller  01:41

In general, the goal of the Chinese government, going forward, is to keep the currency stable with probably an upward appreciation bias. The reason for that is that the dollar is a stabilizing factor on yuan, and the goal of the Chinese government right now is to push the country more towards consumption. One of the easier ways of doing it, not easy, but easier than some of the other ways, is to empower households to purchase more. A way to empower households to purchase more is to put more purchasing power in their pockets, and a stronger currency will do that.

So the bias of the Chinese government, in a non-volatile economic scenario, is to keep the currency stable, to keep it relatively strong, particularly, to the rest of the world to empower Chinese households going forward and to empower this rebalancing idea where the economy will shift gradually to more of a consumption culture. In the past, seeing the currency move, and certainly, if the Chinese economy is under great stress, or a trade war, or during an outflow crisis, or because of some other dynamic, then you’ll have a lot of pressure on the PBOC to allow greater depreciation. But as we all know, the PBOC’s role has essentially been to step in and strengthen the currency when market forces have been pushing it downward. So the PBOC has had mostly a stabilizing strengthening for years now, and that’s the way the Chinese government would like to keep it.

03:13

The idea that there’s a big devaluation in the wings the next time there’s a downturn of the Chinese economy is very, very unlikely. The way we describe this is a breaking-the-glass type of emergency mechanism. It’s there. They could devalue if they absolutely have to, but it would reverse everything else they’re trying to do, so there’s no real interest in a major devaluation. Again, what they want stability, a bias towards strength and in anything other than an extremely supercharged dollar world. That should be manageable, going forward, as long as the domestic economy itself remains stable.

Stig Brodersen  03:46

There is something magical about this one to seven (1:7) ratio, and something that a lot of people have been looking out for for a long time. At the time of recording today, it’s March 10, and one US dollar is worth 6.96 Chinese yuan. But could you talk to us a bit more about what is the “healthy fluctuation”? How much would the People’s Bank of China allow, if we can even use that word?

Leland Miller  04:12

Well, rather than saying it’s a particular percentage or number, I would say it’s whatever fluctuations don’t bother the rest of the world. Don’t make them think that there’s instability in the currency. The reason that this window management has broadened over the course of the past several years has been that people have been more confident in the Chinese government’s ability to manage that ban.

2016 was a horror story for the Chinese government. They’ve learned some of their lessons from that. They realized that markets don’t take well to baby depreciations because they think they usher in large devaluations. The Chinese government’s learned lessons. And again, there isn’t a specific number here. It’s just whatever band the market feels comfortable and without thinking that there’s panic from the government or inside the Chinese economy.

Stig Brodersen  05:02

I like the way that you phrase this, Leland. It takes me to the next question that I have for you. Let’s talk about the US-China trade war. One of the reasons why we did want to bring you on is because you are an expert in China. You expert in this relationship between the US and China. We would really like to zoom out a bit more and talk more about the big lines and the geopolitical situation.

Now, if you look back January 15, the first sign of truth was seen when the US and China signed the long-awaited Phase 1 trade deal at the White House, easing 18 months of trade tension between the world’s two biggest economies. Could you talk to us about what has happened since then in the trade war, and what do you as an expert look out for, in particular?

Leland Miller  05:48

The trade war is on an indefinite hiatus. What that means is that President Trump got commitments for large-scale purchases through the election and beyond. If the Chinese either adhere to those commitments, which is highly unlikely –it’s not going to happen, actually, or they come close or they look like they’re giving their best efforts, then you may see complete trade peace for the remainder of this year through the election. It’s in the Chinese government’s interest to focus inward. If they can take care of the trade tensions with some promised buys, it’s not comfortable for them, but it’s better than the alternative.

For President Trump, there are a lot of elements to this US-China trade war has been supposedly about. There’s been forced technology transfer, IP overall, and market access for foreign companies. But what really makes Trump tick and what he’s focused on is the bilateral trade deficit. As a result, as long as Phase 1 looks like it’s solving, at least temporarily, some of the woes of the bilateral trade deficit, his administration has been focused on playing the trade war down, particularly through the election, and not focusing on any of the other big issues. So, as long as the Beijing president is happy on purchases, then you have trade peace through the 2020 election.

07:13

But one issue here is that this should not be looked at as a two-year deal. It should more fairly be looked at as a one-year deal because both sides are very incentivized to keep the peace through the first year. President Trump hopes it gets him re-elected. Beijing hopes it buys them some time to focus inward. The second year’s going to be trickier because the numbers are so high –that’s even before Coronavirus hit, that it will be very, very difficult to come anywhere close to hitting the targets that Beijing has agreed to particularly without violating obligations and without interfering in other trade relationships that Beijing has.

So the first year of the deal is seen as being relatively fluid in terms of maintaining the peace and, particularly, with the Coronavirus hitting, the second is going to be up to an entirely different story. We’ll have to see what the state of the global economy is at that point. There’ll be very different political considerations for the US side, in particular, and so, there may be very different considerations in terms of whether this deal continues much beyond the first year.

Stig Brodersen  08:14

Having said that, and with the press going so many different directions whenever this was covered, and still today, what would you say as an insider, if you allow me to call you that? What would you say is the most misunderstood whenever we’re reading and learning about this trade war?

Leland Miller  08:32

Right. I think what’s misunderstood is what it’s about. I think people are starting to get this idea, but it’s not widely understood enough. When the United States started what is now seen as this US-China trade war, it was about bilateral trade deficits. It started with Section 301 investigation, which again, focused on problems the United States has historically had with the Chinese government in terms of restricting market access, technology transfer, IP infringement, and core structural issues. It also had to do with something called Made in China 2025, which is the fact that the Chinese government had a very high-powered program to supercharge its advanced manufacturing, whether that’s 5G or quantum computing, or artificial intelligence, etc., and to do that with a heavy-state hand. This was planned with the attempt, and this was explicit, to run the rest of the world out of advanced manufacturing, and become the world leader in all these core sectors.

One of the frustrations that many people have, including my self, is that, as you work through what we just did in Phase 1, this wasn’t about curing any of those structural woes. As a matter of fact, Made in China 2025 got taken off the agenda very, very early on in the process. This was purely about purchases. This was purely about managing the bilateral trade deficit. As a result, if this is all we get, if Phase 1 isn’t Phase 1, but Phase 1 is the US-China trade deal, then we’ve given up a spectacular opportunity and an enormous amount of leverage to effectuate real change in return for some very transient commodities purchases that may actually work against us in a few years when US farmers, for instance, become more dependent on Chinese markets, giving Beijing more leverage over US economy.

Stig Brodersen  10:17

You know, one of the things that I found very fascinating whenever reading and learning about this is how we hear the US side focus on the different parties. The White House has its own agenda. The corporations have their own agenda. And the unions have their own agenda. But let’s try and turn the tables, and look at the major players on the Chinese side. I think it’s very interesting to see because I think, in the US, we tend to see that we might have different interests, but China is this one uniform entity that wants XYZ. But there are a lot of different players in China, too. Could you talk to us about some of the bigger players?

Leland Miller  10:56

There certainly are these different players with different vested interests. The difficulty is saying anything and knowing you’re right. There’s very little visibility into how some of these political battles are waged. So it would be a mistake, as you suggested, to think that Xi Jinping runs a monolithic China. What he says, goes, and China has one opinion about reform or restructuring or trade deals, or the state of the currency, or GDP targets or any of the core issues.

The problem is that it’s not always obvious who’s pushing back, especially the senior levels of the party. Certainly, during the US-China trade war, President Xi was getting enormous pushback domestically on some of the things that he was offering up. There were suggestions in the media and by public intellectuals. There was discussion, certainly, on the online blogs about how China wasn’t taking a tough enough stance, etc. It’s hard to pinpoint who some of these actors are. It’s bad for their health to self-identify, but certainly, there’s a very diverse discussion behind the scenes. It’s just not always easy to figure this out. We do know that, certainly, PBOC has its own vested interest, NDRC has its own vested interest, and, certainly, very ultra-rich Chinese have their own vested interest. There’s a diversity of opinion, but it’s not always transparent who’s holding what view at any given time.

Stig Brodersen  12:14

So, Leland, I’m really excited to speak with you here today, because you’re coming from China Beige Book International. We’re not just talking about the conventional metrics like GDP, inflation, and unemployment. You also track those, to be fair, but it’s just such a wealth of information of what you guys are doing. But perhaps before we dig deeper, could you give us a helicopter view of the Chinese economy, especially how that is different than the US economy?

The Chinese growth rate, even though it’s nowhere near 6% reality has been much stronger than the United States for many, many years now. Part of that’s because China, in many ways, is a developing economy and not a developed economy. The incomes of the average Chinese are a tiny fraction of what they are in the western democracies. China is this big, powerful economy, the second largest in the world, but also is developing in that it’s not rich. Its people are not rich. And so, it has very interesting facets of both the developed economy and a developing economy.

The historical reliance on growth for China has been based around investment. What that essentially means is that when the Chinese government wants to spur growth, the government steps in. It builds usually heavy transportation and heavy infrastructure. It creates growth that way. Now, the problem with this, of course, is that many of these development programs are non-productive. As a result, they’re spending an enormous amount of capital on programs that are not adding to productivity in the economy.

Now, this has been okay for a long time, because even though China has built up an enormous amount of non-performing loans from some of these projects that just aren’t returning any investment. The country got richer, people have gotten richer, and growth has been fast enough to keep pace with debt –that’s no longer true, but it’s going fast enough that there hasn’t been a problem. We’re entering a new era, so there’s a lot of fear on the part of the Chinese government that the old method of continuing to just spend, spend, spend is not going to work as China’s debt load gets too critical and as the economy slows down. And it doesn’t slow down because of mismanagements, per se. It slows down simply because so much good money has chased after bad for so long that the return on investment of projects of companies inside the economy has slowed down. As a result, you’re going to have much slower growth going forward no matter how well the economic officials in Beijing operate going forward.

So, you’re going to have to manage the economy in a very different way. I think there’s a sense of urgency in Beijing about managing the economy in a different way. The question is, what type of problems are you willing to deal with along the way that won’t make you turn back and run scared back to the old method? What type of economic dislocations are acceptable, and which ones are not? I think where this gets into particular problems is when you start talking about the job market. You start talking about potential layoffs. It’s one thing to talk about how you’re going to restructure the economy, to allow zombie firms to fail, and allow state firms to stand on their own two feet and compete with private firms. But if you see firms going under or you see financial products defaulting, then you see risk injected in the economy. That means there’ll be failure. And if there’s failure, that means there are economic losses and job losses.

These are very difficult concepts for the party to digest because, for a long time, there haven’t been any. So this is a very critical time for the Chinese officials for Chinese economic policymakers. How do they transition to a risk-based economy that allows the government to not have to backstop everything explicitly or implicitly because they can’t, in reality, do that? How do you translate the old system into the new system without causing problems that could threaten the party’s existence? That is the story of current-day China.

Stig Brodersen  16:09

Since you say that, I can’t help but ask, how do you do that? For you to answer that question, I know that’s an ungrateful question. Like you mentioned before, fiscal policy, there’s a method to do it while you’re developing countries. You have to do your policies differently than you’ve done in the past. You can’t build yourself. You can’t just throw money out in society and then growth will come from itself. What are you looking for? What is a sound fiscal policy in this day and age for China?

Leland Miller  16:35

To give Beijing credit, they have been moving in that direction to some degree. You saw in 2016, the economy was recovering from the early market’s panic of January/February 2016. It was all through infrastructure stimulus. It was back to the old way of China’s heavy investment. You have not seen that leader since. You have not seen that economy weaken in 2018 and 2019. You did see the stimulus. You saw a very directed stimulus to provide capital to small and medium-sized enterprises, for instance, and private firms. But you do not see the build, build, build type of programs that you saw in the past. That’s very positive because it means the Chinese government is understanding that there are limits to the old model, and they’re trying to transition.

Now, our advice for a long time has been to stop focusing on GDP growth. Do away immediately with the GDP growth target because it means nothing. One, the number is manipulated. But even if the number was not manipulated, GDP growth doesn’t mean what people think it means. GDP growth relates to our production growth. We used to joke that if China wants 7% or 8% GDP, all it has to do is build a bridge, tear it down, build the same bridge again, tear it down, build it, tear it down, and keep going until you get the 7% GDP. You’ll hit the number because this is a mathematical construct, but you’ll have a thoroughly unproductive use of those funds. That’s what China has been doing to some degree for many years now.

So the getting away from a reliance on infrastructure investing has been positive, but what Beijing has to do is change the conversation from being all about growth to being all about strengthening the economy for the long haul. Get away from the idea they can grow at 6% growth, because what we’ve been saying for many years now is that within the next decade, possibly much sooner, China will be growing at one to 2% growth at most. That’s where we’re headed. What Beijing is well-advised to do is tell people about this earlier rather than later, and say this is a way for the Chinese economy to develop in a sustainably stronger way, rather than rely on artificial levels of growth that run the risk of having a debt crisis or a stagnant economy, which is similarly problematic.

Stig Brodersen  18:41

It’s very interesting that you say that. I also think it’s interesting for the listener to know that the Chinese economy is just constructed very, very different than what we’re used to in the US. So not to do too much macro 101, but if you look at how this GDP number is constructed, you have there the consumption, the investment, and the government expenses. If you look at the US economy, and this sort of unique even for a Western developed country, but as much as 70% is consumption-driven in the US. It’s a very different GDP number that you would have in the US than you would in China. It has very different implications depending on how the government acts in China.

It sort of leads me into the next question, because perhaps by comparing to the US, for us to get a better grasp of how it’s the same or how it’s different, could you please explain the relationship between the Chinese economy, the People’s Bank of China, and the Chinese government? How do those three interact, and how is it different or the same, as in the US?

Leland Miller  19:43

The most important thing to understand about the way that the People’s Bank operates inside the Chinese economy is that China is not a commercial financial system. This is a point that even very sophisticated traders that we work with constantly get wrong.

The idea after the financial crisis was, well, the United States had its problems. Europe had its problems. China’s next. But the Chinese economy doesn’t work that way because it’s a non-commercial financial system. The government can order capital to be pushed from one side of the system to the other side.

Essentially, if a state entity needs capital, then another state entity will provide that capital, and you’ll continue to patch holes on the ship. So you never have an acute crisis, but you have a long process of the People’s Bank and other financial entities in the economy consistently providing capital to firms that need it so they don’t fail. The problem with that is you’ve got a lower return on investment, you get a lower return on productivity, and you’re essentially leading the economy into stagnation. There are advantages, of course, to this approach.

One of the questions when Coronavirus first hit was what’s going to happen to millions of Chinese firms who only have one or two or three months’ worth of cash flow? Are you going to see a million small or medium-sized enterprises default across the Chinese economy? The answer was always no, because as long as it’s a policy priority for the Chinese government to not allow this, then it won’t happen. Of course, you’ll have losers. Of course, you’ll have firms that don’t survive. But essentially, the system is state banks loaning to state entities, and state banks loaning to small and medium-sized enterprises.

When the state controls all the counterparties, then you’re going to have a system that doesn’t freeze up the same way. You’re not going to have a liquidity crisis because the government is ordering some firms to lend and other firms to borrow. Now, that allows you to avoid an acute crisis in any particular instance, but it also leads to a long-term path towards stagnation. Good money continually chases bad and productivity declines, so the economy works very differently than in the United States or in the Western world. But the single most important facet of that is how different China’s financial system works.

Stig Brodersen  21:53

Very interesting and something that I’m happy to say that we will get back to here later in the interview. It is a very unique financial system for sure. Now, China has, for many years by a lot of people, been considered the primary growth-driver, not just for Asia but for the global economy. As you mentioned before, we’ve seen double-digit GDP growth in the past. Today, the official numbers are closer to 6%. Is it the same number you see in your data? What is driving growth in China? Or, perhaps the lack of growth might be a better way of asking this question.

Leland Miller  22:27

To give one example of volatility that we see in the numbers that is never acknowledged by Beijing, the weakest national growth that we’ve seen in the last 10 years of serving the Chinese economy was the fourth quarter of 2015. Chinese official GDP growth that quarter, I believe, was 6.8%. The strongest quarter that we’ve had in the last 10 years was arguably the run-up to the party congress 2017. China’s official GDP growth that quarter was 6.8%. The idea that the strongest performance we’ve seen in the last decade and the weakest performance both had a 6.8% GDP growth level tells you all you need to know about how accurate these figures are. The GDP figures are meant to signal stability. They’re not economic numbers. They’re political numbers.

Stig Brodersen  23:18

What are the three most misunderstood facts about the Chinese economy in the West?

Leland Miller  23:24

Number one, there are no fully good unmanipulated pieces of Chinese data. One of the things you learn when you start doing deep dives into official data on China is it’s not a case of one headline number, like GDP becoming manipulated. If you just dig beneath the surface, you get this gold mine of rich, honest information. The truth is that any number that markets begin to rely on, the Chinese go back and manipulate it.

For instance, there’s been this idea that the Li Keqiang index, which is this mythical beast, in which its electricity consumption and rail cargo, etc., is somehow this real way of looking at the economy. Well, as soon as the Li Keqiang index started being used by financial firms around the world, the Chinese started manipulating electricity consumption data. They started offering up some very questionable real cargo data. I think one of the takeaways on this is that there simply are no pieces of official data that can be trusted because the Chinese want these numbers to be political. They want them to signal stability. If they’re not signaling that, then they’re a problem.

24:26

The second I would say is related to that. The idea that the West does independent China analysis, the state of the industry I’m in is not good. The people that are in it are very smart. The type of assessments that are being done on the Chinese economy right now, however, are very, very poor. We’ve been making fun of these Reuters polls to come out with greatest contra-indicators ever that whatever economist in the Reuters poll thinks about the economy during the early days of Coronavirus. They were predicting 4%-5% growth in Q1. Prognostications have gotten worse in there, but what you usually see if you dig deep enough into the western analysts of China, they’re typically either opined based on Chinese data, or they’re creating some sort of leading indicator that’s a composite of a bunch of different numbers. But those numbers are all sketchy Chinese government official numbers to start with.

One of the rules that we try to explain to people is that the first and second derivative of trash is trash. So, most of the instruments being used outside of China to evaluate the Chinese economy are just not worth looking at. It’s something I think people are understanding more and more now that instability in the Chinese economy is not being signaled when it should be based on these instruments.

25:41

The last I would say is, no matter how many times we talk about it, no matter how many times traders lose, there’s not a widespread understanding that China does not have a commercial financial system. China’s financial system is strictly non-commercial. It allows them to do amazing things in terms of avoiding these acute crises as we talked about earlier. They’re able to avoid significant problems. They’re able to avoid the hard landing scenario, but it causes a lack of growth in the long run as debt wildly outgrows growth. This is the problem going forward. The non-commercial financial system that China utilizes has enormous advantages in terms of maintaining stability in the short- and medium-term, but there are significant long-term costs. That is not understood by some of the more sophisticated people.

Stig Brodersen  26:28

You hear so many stories, but it seems like there are so few insiders who actually do understand what is going on. Or, at least, I could say, there have been few outsiders who understand what’s going on on the inside of China.

Now, could you please first explain how shadow banking is different from commercial banking, perhaps for those who are not too familiar with those two terms? And why is it important to understand shadow banking in detail to understand the economy of a country?

Leland Miller  26:56

Any type of financial institution or instrument that provides capital outside the banking system is a non-bank, and therefore should be considered a shadow bank. So, the simplest way of looking at this is anytime that money’s being handed out in the economy, and it’s not from a bank, it’s from a shadow bank. It’s a very broad definition. Now, this gets tricky, very, very fast. And one of the reasons it gets so tricky is that shadow banking can mean non-banks you borrow from, or it could mean financial instruments that are shadow banking instruments, wealth management products, trust products, negotiable certificates of deposit. So when you’re trying to understand from a quantitative standpoint, how much of China’s financial intermediation is shadow banking, how much of the economy is fueled by shadow banking versus bank lending?

Now, shadow banking has gotten a bad name in China and elsewhere, because it seems like the Wild Wild West. That’s fair. A lot of shadow banking in China are Ponzi schemes and non-transparent instruments. There’s a lot of garbage out there. It’s very, very dangerous to households and to the Chinese financial system. Shadow banking is also very, very necessary and natural. It was a result of the fact that the Chinese banking system is geared towards providing cheap or no-cost capital to state enterprises, and massively disadvantaging other types of entities, like small and medium-sized firms, private firms, and others, because state firms and state banks have historically been restricted from offering pricing risk, from offering capital at what it should be costing. So if you’re only able to doubt 2% loans, banks are left with the difficult problem of do we give it to state-owned enterprises which are politically back? Do we take a risk on some of the smaller firms that might go? Of course, it’s very natural that the state banking system has gravitated to larger firms which are bigger bets, and which are more politically connected. But as a result, huge chunks of the economy have not been able to remain capitalized without some sort of outside intervention, and that outside intervention has been shadow banking. Shadow banking has been a way of working outside the banking system to provide capital. Without shadow banking, China wouldn’t be where it is right now, both on the good side and on the bad side.

Stig Brodersen  29:07

Thank you for outlining the concept on a more conceptual level. If we become a bit more focused on what’s happening today, what does your data tell you about the trends in shadow banking in China right now? And what are the implications of those findings?

Leland Miller  29:23

The Coronavirus may change some of the landscape simply because of firms without revenues. There’s a demand shock. A supply shock is a global demand shock. There’s an oil shock. The landscape of shadow banking may, therefore, change in 2020 because of the dire needs of the economy, but I can outline what we’ve seen over the past year. It’s been a very different story than what you’re hearing about even from international institutions like the IMF or the World Bank who simply take Beijing’s official numbers and extrapolate from there.

We’ve seen a dramatic rise in shadow banking over the course of 2019. To understand this, you go back to the fourth quarter of 2018. The economy saw some of the worst results. Every sector and every region were weaker. The headline metric was down, and something happened in Beijing to change economic policymaking going forward. There was some sort of equivocation. Do we focus on restructuring and deleveraging and reform going forward? Or do we batten down the hatches and protect ourselves against a slowing global economy and President Trump’s trade war? And what you saw was an explosion of bank lending at the beginning of 2019. It was not just a jump in loans to the normal firms, but a much broader distribution of credit provision to funds that don’t typically get the type of capital they need. Again, these are small and medium-sized enterprises, private firms and others. The disadvantaged firms started getting better access to capital.

This is the type of stimulus we saw in 2019 instead of infrastructure investment. As the year went along, it soon became clear that banks were resistant to keep sending their funds to small and medium-sized enterprises and private firms because they were riskier. As a result, we saw a resurgence of shadow finance as 2019 gained steam. The most interesting part of this resurgence of shadow finance –which again, did not manifest itself in total social finance data so it was not seen in official data, at least until the very end of the year. But the most interesting facet is what popped up. What we started seeing in the middle of 2019 was the rise of something called the government on shadow banking, which became these credit appendages.

For instance, you’d see shadow banks serve as an intermediary function between formal banks and small and medium-sized enterprises, capturing the marginal on the way, and saw shadow banks being used not just by the private sector, but by the government in order to steer capital inside China’s banking system and financial system. This is not ideal. It’s rather wasteful, but it shows the extent to which there are real worries about how to get certain firms capital that the banking system can’t solve the problem. And as a result, the government often gets very creative.

32:03

Now, why did you not see an uptick in the number for shadow banking? That’s a good question. One of the reasons might have been that all the high ranking officials, including Xi Jinping in China, for the preceding several years, had talked about how they had wiped away shadow banking, so it may have been very politically difficult to announce that, “Hey, now we’re suddenly relying on it.” In any case, we saw this resurgence of shadow banking. It did boost the growth numbers and other numbers across the economy more than we expected, but the downside of that is, by the end of the year, even with the surge in loans in the banking system, and even with the resurgence of shadow finance, and even with historically high bond issuance, the economy was still slowing down. So even though 2019 saw a dramatic increase in credit provision across the economy, most of this unannounced, still saw the economy not able to stay stabilized but continued to slow. That was a big worry, and it’s one of the reasons the Chinese came back to the negotiating table of the trade war. It’s one of the reasons why there’s a more conservative effort to deal with the economy going forward.

Stig Brodersen  33:08

So, Leland, China’s economy has rapidly changed over the past few decades. At this stage, the world’s perception of China has changed. Perhaps, even more importantly, China’s self-perception has changed dramatically. Looking away from geopolitics, if that’s even possible to do that because it’s all interconnected, what are the implications for the global financial markets now that China is the second-biggest economy in the world? And most people would say it’s faster than anyone else at the top.

Leland Miller  33:39

China’s this land of opportunity, but it’s also the land of missed opportunity. We’re in a low-rate world that’s getting lower and lower and lower and lower. As for attractiveness, even risky Chinese investments will increase if you’ve got yielding investments in China at relatively strong yields compared to the rest of the world. There’s this wonderful opportunity China has to reinvigorate its financial system by opening up and allowing foreign capital in, and not having to pay too high rates for it, because the rest of the world is close to, at, or below zero.

So, on one hand, you’ve got this enormous opportunity. Financial firms are paying to get into China and take advantage of the relatively untapped market. On the other hand, you’ve got a political system that doesn’t want to relinquish control. As a result, the idea of throwing billions, or tens of thousands, or hundreds of billions into Chinese markets is a very risky proposition because you don’t know when you can get your money out. You don’t know whether it’s going to be treated fairly while you’re there. You don’t know if it’s going to be not disadvantaged against domestic actors. And as a result, you have this very murky prognosis on the future of investment in China. Every financial firm is trying to get into China. Every company, every financial firm is talking about how they want to expand in China, but at the same time, they realize that without the rules changing, and Beijing’s position changing on some of these things, it’s going to be a losing proposition.

Stig Brodersen  35:00

Interesting. So Leland, we primarily have equity investors in our audience. What is your number one advice for us who are interested in investing in China, for those of us who do look at it as the land of opportunities?

Leland Miller  35:15

I would say: Don’t believe everything you’re told. I’m beating this drum a lot, and I’m going to continue to beat it. Sometimes conditions are much worse than what’s announced. But on the other hand, you’ve got the opposite problem, too, because nobody trusts what’s happening inside the Chinese economy in terms of data, and they don’t trust Beijing’s pronouncements, but sometimes you have overreactions.

If you look back at Summer 2015, it was one of the most interesting times because we watched the market get increasingly frazzled and over-developed. First, the Chinese stock market crashed. Second, the manufacturing index crashed. And strike three, later that summer, was when the Chinese yuan depreciated just a bit and everyone thought this was the beginning of currency wars and a major devaluation. With strike one, strike two, strike three, everyone went into a panic. People got defensive. They tried pulling their money from China. They had one of the more serious crises in the last decade inside the Chinese economy. But what’s so interesting then was that we weren’t seeing any of it in our data.

In 2015, it was actually the opposite problem. Markets were scared to death that something terrible was happening in China. We were actually cracking open our data, not just for that month, not just that week, but day by day, and we were seeing numbers that came in that weren’t problematic. The economy was slowing a bit, but it was slowing very similarly to what it did the quarter before and the quarter before that. And so, what was very interesting is that reliance on trust in the Chinese government message had fallen to such a low point that people were trusting these anecdotal pieces of evidence of problems, stock market problems or manufacturing index low or what they thought was a currency devaluation, rather than any data in China. As a result, markets went down 20-30%. We called it one of the best buying opportunities we’ve seen in the last 10 years.

37:00

The problem is that China is a wonderful opportunity, but again, it’s very difficult to trust Beijing’s message because they have a vested interest in selling us a stability narrative. As a result, people miss out on the upside and they miss out on the downside. That’s a real problem that people don’t trust the data inside China. They don’t trust Beijing’s pronouncements, and as a result, you often seen financial actors just scrambling to figure out what’s going on.

Stig Brodersen  37:27

I’d like to sort of turn the tables and then ask is there a premium to be gained in the Chinese stock market or part of the market because of this? Since everyone knows the fake data that a lot of people are scared to enter, is there such a thing as the bold, and perhaps the stupid also, having an advantage or a premium to be gained because of that general perception?

Leland Miller  37:51

Yeah, look, there are hedge funds that do very very well vesting in the Chinese marketplace. Most of them are Chinese and have an advantage and informational advantage one way or another. But if you think you’re one of them, you better be sure you’re one of them. Because it’s very hard to get true insights into the government’s thinking. The reality is that the A-share market is guided not by fundamentals, not even by macro factors, but based on what government policy is at any given time or what the government wants to signal.

There are not that many things you can invest in. In China, you can invest in equities. You can invest in bonds. You can invest in property. You could invest in commodities or commodity futures. You could put your money under your bed. There are not that many options. When the government signals that it wants to either steer capital towards a particular area, say the bond market or equities or property, or pull money away from an overheating property sector, that will guide the directionality of the A-share market more than any other factor in the entire universe. There are ways of figuring out where to invest based on the right factors, which are where the government is looking and is suggesting people. However, it’s very difficult to get ahead of the curve on this if you’re not a very connected Chinese firm with very good governmental connections. So absolutely, there are ways to make money in the Chinese stock market.

Stig Brodersen  39:14

Leland, thank you so much for coming here on The Investor’s Podcast and sharing your knowledge about China and the Chinese economy. That’s been absolutely amazing. We definitely want to give you the opportunity to talk more about where people can learn more about you, China Beige Book International, and some of the reports that you send out.

Leland Miller  39:34

Certainly! @ChinaBeigeBook on Twitter. We’re very active on LinkedIn, as well. Just to say, early going, we spent a lot of time working underneath the radar, advising firms on how to operate, explaining to everyone, here’s what you need to know about China, here’s what we’re seeing in China, and here’s how to stand up in big-time danger.

Stig Brodersen  39:53

Definitely noted on that. We’ll make sure to link to all of that in the show notes. Leland, again, thank you so much for taking time out of the busy schedules to speak with Preston and me here today on The Investor’s Podcast.

Leland Miller  40:04

My pleasure!

Outro  40:06

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