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Why Still Spoon out Porridge When the Pot Is Broken?

The Logic of Future Asset Allocation Has Changed Completely

{Editor’s Note: An article discussing the change of direction in China’s financial strategy has spread on the Internet. It is said to have been based on an anonymous speech that a guest delivered at a salon session in Shenzhen, Guangdong Province. The speaker asked to remain anonymous. The following is a transcript of excerpts from the article.} {1}


First of all, I want to clarify the host’s introduction (about me). I am not a think-tanker. Nowadays, even think tanks do not know (how to manage investments in China). I am just a little closer to the decision-making circle. The information I have access to and the perspectives I have on the issues are, to some extent, different from those of you who make investments.

In addition, I have been told that this session is simply a small internal exchange. I will do my best to speak my mind based on what I know. I will tell the truth, get to the point, and not beat around the bush or run in circles.

Many people ask me, “What does the government really want to do now?

Whenever people speculate in the stock market, the government suppresses it. When they speculate in the stock market with the Xiongan concept in mind (the Beijing municipal government is relocating to Xiongan, Hebei Province and this could potentially drive up the market and the price of real estate in Xiongan), the government suspends trading of the shares of a few companies. {2} When the market expanded because companies gave out shares as dividends, the government called out those companies to criticize them. When the speculation focused on specific industries, the government attacked those companies. … This is just gradually putting the stock market into coffin.

The housing market is no different. (The government) restricts loans and restricts purchases according to chosen criterion: types of people (whether people have residence status in the city) and types of loans (whether it for their first house). As if this isn’t enough, the government has now placed restrictions on sales. It amounts to completely separating buyers and sellers, so when the government plays this game, even if the housing market does not die completely, it will scrub off a few layers of skin.

The stock market and the housing market are dying a slow death. For such a sacrifice, what purpose does it serve?

This question hits the nail on the head.

The most common mistake that investors make is to look at their narrow patch of land in front of their tiny little stool. Most of the time, they do not even understand what the government really wants to do, now and in the future, and what the government’s biggest concerns and pursuits are.

What is the significance of looking from the government’s perspective on investment?

It is simple. Our economy is still a planned economy. Our State-Owned Enterprises (SOEs) monopolize more than 80 percent of the land and natural resources and more than 70 percent of the credit resources. With this economic structure, if investors do not study the government’s needs, but instead watch the central bank, the exchange rate, the CPI and the PPI (as people do in a free market), aren’t they blind? Don’t they know where those numbers come from? (Editor’s note: the author implies that the economic indicators in China are not collected from market data; rather the government makes them up.)


Logically, the government’s focus is the whole of China. However as its resources are limited, it must adopt a relatively balanced, coordinated plan.

There is an exception. When the economic situation demands some sacrifice, it is inevitable that the government abandons the less important business to protect the more important one. (Right now, it is the stock market, the housing market, and the whole virtual economy that are being sacrificed.)

The government has been very determined to suppress the stock market and the housing market. Why? Very simple. If they are not suppressed, the virtual economy and the real economy will die together.

In the past, we had two pools of money: one was the real economy and the other was the virtual economy. In accordance with our past experience, both of them are bundled together and have a causal relationship. None is too far away from the other. Money maintains a dynamic balance between the two pools.

This experience has been basically correct in the past, but it is no longer the case whatsoever. Over the past three years, we have issued 78 trillion yuan (US$11 trillion). What was the increase in the GDP? 14.88 trillion yuan. Where did the money go?

Housing and the stock market.

In 2016, China’s primary housing market had sales of 11.7 trillion yuan and the secondary housing market had sales of 5 to 6 trillion yuan, totaling 17 to 18 trillion yuan. Last year M2 (cash and highly liquid assets such as stock) increased only 15.5 trillion yuan. The increase in M2 was not enough to cover the housing transactions. A large amount of cash was changed into reinforced concrete or a variety of transactional assets, further away from productive assets, resulting in the rapid decline in the asset’s ability to generate cash flow. The products in the real economy simply cannot keep up with the rising prices in the virtual economy and are forced to bear the cost of the price increases in the entire economy. It is more and more difficult for the real economy to breathe, and the debt pressure that originally was not obvious has now become a focus of attention.

The increase in yield in the housing and in the stock market, in turn, pushes up the expected rate of return on capital. On the one hand, the money that flows into the real economy goes into the housing and the stock markets through different channels. On the other hand, the real economy’s financing costs keeps increasing, in spite of the government’s easing monetary policy. The recent financial crisis in private enterprises in the northeast and Shandong Province, in fact, bears a direct relationship to the capital market bubble.

In other words, the real economy and the virtual economy are actually not connected to each other – they are parting ways. The two have formed a de facto competitive relationship. The virtual economy is not supporting but rather, siphoning blood from the real economy.


The reason why we are riding the tiger and cannot get off is because we keep procrastinating (in resolving the conflict between the two economies).

Our past experience was to expand the economy with the hope that the problems would automatically be solved during development. However, while some problems can be solved by continually adding water (to dilute the solvent), others cannot. In some cases, a blemish on the skin may not be a problem at the beginning, but as your body expands and passes its constraint and support limit, it rapidly grows from a minor discomfort to a tumor.

The economic model is like that.

Our economic growth has long been relying on investment. In the past, we argued about whether we should preserve the housing prices (which would require keeping ample money in the market and involve high inflation) or preserve the exchange rate (which would mean containing domestic inflation). The issue was that protecting housing prices is, in fact, protecting investment; protecting investment is protecting the economy. So on the surface, we (had the debate but) did not choose. We actually (ended up) protecting the housing prices. The hidden logic was: compared to depreciation of the exchange rate and the outflow of capital, an economic freefall was much worse.

When housing prices in the first-tier cities (Beijing, Shanghai, Shenzhen, and Guangzhou) doubled within one year, we found that protecting the exchange rate was to cut the ground from under our feet. Protecting housing prices was like taking a poisonous drink to quench our thirst. We faced a horrible horizon: the housing and stock markets not only siphon blood from the real economy, but their own bubbles may burst at any time.

We have never experienced a major economic and financial crisis, but most people now realize, when using their common sense, that if no action is taken, the real economy and the virtual economy will burn down together.

There is only one solution: to drive the money back to the pool of the real economy, at any cost.

How to drive it back? We must suppress the yield from the housing and the stock markets.

This will definitely cause pain, but it is the lesser of two devils. If we don’t smash the two small pots of housing and the stock market, the big pot of the country will no long exist.

When we are smashing those pots, you are still trying to spoon out porridge. You have a problem – you do not have a vision.


(An issue of an economy that relies heavily on investment is that, over time, the investment’s efficiency will drop.) Over the past three years, we have had to use over five units of money (investment) to generate one unit of GDP. The efficiency and elasticity of issuing money (monetary policy) has been declining. The over-supplied currency in the past decades has become the inevitable thorny problem that we have to face today. If this problem is not properly solved, it will be a wild forest fire spreading fast, and we will be running around exhausted, fighting fires all over the place.

Moments ago, many of you said that our stock market fell because the U.S. contracted, so we should contract, too. You also mentioned that the U.S. (entered) the cycle to increase the interest rate, saying that the spread between the U.S. interest rate and China’s interest rate has dropped to a 5-year low. You also said that, in order to ease the pressure on capital outflows, China’s interest rate is bound to rise. This is a typical armchair strategy.

We will not contract (our economy). Nor can we afford to contract it. Zhou Xiaochuan, President of the Central Bank, said that we need to know the difference between talking and doing. The pace of M2 will not drop. We have already given up on tools to control the exchange rate (under the pressure of Trump’s Hundred Days Watch). If interest rates go up (to follow the U.S.’ direction), do you know how many companies in China will be strangled by debt? Debt has already essentially crushed the companies in the northeast and in Shandong Province. Real economy business entities have no money. The money has all gone to the virtual economy.

In the past, we made no attempt to fix the problem. Instead, we gave the runaround and gambled, expecting that a loose and favorable economic environment as well as time would allow economic models and economic structural problems to work themselves out. The reality is that now we are forced to make a decision. Otherwise, it will result in a total burn down.

Therefore, whenever a stock goes up as a result of speculation in the stock market, the government of course cracks down on it. If limiting mortgages, purchases, or sales {3} is not enough to contain housing prices, then the government will, as soon as possible, introduce property taxes or quasi-property taxes (to contain the housing market).

The rate of return in the virtual field must be suppressed.

This is the only choice for scraping the poison off the bone.


China’s GDP in the first quarter of this year was 6.9 percent. This was way too high. It probably will be the highest point of the year. The annual GDP will keep declining.

As of now, PPI year on year growth has peaked. Historically, the replenishment of inventory has been highly in synch with the PPI, so, the efficacy of the replenishment to drive the economy will decline. From the second quarter and thereafter for a longer time, it will be evident that a protracted contraction in real estate will pull down the economy. The trend of GDP this year has been clear, high in the first half and low in the second half.

In addition, it is obvious that the global cash flow will change direction. The U.S. Federal Reserve will raise interest rates and will sell assets to reduce debt. This will eliminate any room and flexibility for China’s economy to enjoy a loose and favorable environment.

The only viable solution (for China) is to move the money to the real economy, which means that the rate of return in the stock market and the housing market must for sure go down.

Therefore, we should modify our investment rationales for a long time into the future.


{1}, “When the Pot Is Being Smashed, Are You Still Trying to Spoon out Porridge? The Logic of Future Asset Allocation Has Changed Completely,” April 19, 2017.
{2} Reuters, “China stocks rise, Xiongan zone, economy in focus,” April 13, 2017.
{3} Limiting mortgages, purchases, or sales in the real estate market: Many localities in China have imposed different measures to control housing prices, including requiring higher down payment percentages for second homes, not allowing non-city-residents to buy a house, or not allowing houses to be sold if they were bought within the last year.