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Xiang Songzuo: The Biggest Change That Has Happened in Forty Years

{Editor’s Note: Xiang Songzuo, a Chinese economist, professor at Renmin University, and former chief economist at the Agricultural Bank of China, gave a speech on December 18, 2018. Immediately, the web video went viral in China’s cyberspace and then suddenly disappeared. In the speech, Xiang pointed out three serious misjudgments China made in 2018, including the economic downturn, the China-US trade war, and the heavy losses in the private sector. On the China-US trade war, he said that China has many misunderstandings about China-US trade frictions, its judgment of the China-US trade war situation, and the judgment of the international situation. He believes that, in fact, the Sino-US trade friction is neither a trade war, nor an economic war, but a serious conflict of ideologies between China and the United States.

The following is a translation of the first two sections of the speech.} {1}

First, in 2018, China made three serious misjudgments.

1. The Economic Downturn

We can say that 2018 has been an extraordinary year. There have been too many big events this year, but what is the most significant event? —— In 2018, it was China’s economic downturn.

What was the extent of the slide?

According to the National Bureau of Statistics, GDP growth was 6.5 percent, but according to an internal report of the research group of a very important organization, so far, China’s GDP growth has been 1.67 percent. Another estimate shows that the growth has been negative.

Of course, here we are not going to discuss whether this calculation is correct or wrong; nor are we going to discuss what data we should believe. This year, China has seriously misjudged this issue.

2. The China-U.S. Trade War

Have we misjudged the China-U.S. trade war? Have we underestimated it? Now the China-U.S. trade war has been going on for almost a year. Let’s recall the remarks that the mainstream media made at the beginning of the year: [By engaging in] the China-U.S. trade war, the Americans are shooting themselves in the foot, and China will win; if China wants to fight, it will be a big win for a big fight, a moderate win for a moderate fight or a small win for a small fight.

Where are the mainstream media that made these remarks? After all, as of this date, we have a lot of misunderstandings about China-U.S. trade frictions and about our judgment of the China-US trade war situation and the international situation. This is worthy of our deep reflection.

In fact, the trade friction or trade war between China and the United States is no longer a trade war or an economic war. It is a serious conflict of ideologies between China and the United States.

It can be said with complete certainty that China-U.S. relations are now at a crossroads. China-U.S. relations are now facing a huge historical test. I don’t think we have found a real and proper solution.

We all have recently noticed that Huawei’s CFO Meng Wanzhou was detained in Vancouver. The BBC and other media are reporting that the U.S. allies are going all out to contain Huawei. What does it mean? This is not a simple trade and economic issue.

In the past, we had a saying that China’s economic growth has a period of strategic opportunities. Does the period of strategic opportunities still currently exist? I personally feel that our period of international strategic opportunities is now rapidly disappearing.

3. The Hard Hit Private Enterprises

From various data, we have found that private investment, or investment in private enterprises, has slowed down sharply and the confidence of private entrepreneurs has been hit hard.

From the beginning of the year, until November 1 this year, when national leaders held a special meeting, the numbers of arguments for the elimination of private ownership and the exit of the private economy have been rampant. Now some people are saying that, because the economy is not doing well, we are starting to please private enterprises.

Therefore, [we have] the downturn of the Chinese economy and the pressure on the Chinese economy, including the worsening of the China-U.S. trade war. We must reflect on what we have done wrong. We must reflect on what we should do to give an actual boost to the Chinese economy and truly bring about the steady and sustainable growth of the Chinese economy.

Second, we are now facing five problems

The problems we are facing are primarily our own problems, but, in many discussions, they have been understated.

1. The wrong tendency in economic transformation

Our economic downturn is a long-term downturn. It is not a big problem in and of itself, but we all noticed that we are now relying on consumption and the tertiary industries, which accounts for 78.5 percent of GDP growth.

According to our official announcement, this is a good thing. The economic transformation has been successful. In the past, we relied on investment and relied on exports; now we are relying on consumption and the tertiary industries. It sounds like it makes sense.

We should be aware that, in a country like ours, investment has slowed down a lot and we are relying on consumption. Can we still maintain economic stability?

On the one hand, this may be good news. On the other hand, and more importantly, it may be bad news.

In the past 40 years, we had 40 years of reform and opening up and we had five consumption waves. The first was to solve the problem of food and clothing. The second was the “three big new items” (the refrigerator, the color TV, and the washing machine). The third was information consumption (the personal computer and cell phones). The fourth was the automobile; and the fifth was real estate.

Now, the five waves of consumption, as you can see, are basically nearing the end. The consumption of cars is falling sharply, as well as the consumption of real estate. So now we are facing huge problems.

Financial risks have intensified

While the economy is slowing down, financial risks have intensified. The shadow banking that previously attracted large foreign investments has now shrunk sharply. A lot of media have said that the inconsiderate policies, lack of coordination, derailed execution, and compounding effect of strengthened regulations have led to the credit crunch. This is, of course, an important reason, but actually, not the most fundamental cause.

We now see that the size of direct financing markets, either bond financing or stock financing, have dropped by half this year and more loans have gone into default. Before October, that is, in the first three quarters, the default in corporate debts exceeded 100 billion (yuan, US$14.8 billion).

According to official data, the default in corporate debts will exceed 120 billion (yuan, US$17.8 billion) this year and a large number of enterprises will go bankrupt. Currently, enterprises are falling down in large numbers. State-owned enterprises are also falling down.

Bohai Steel was among the great “Fortune 500.” When it initiated bankruptcy proceedings, its net liabilities were 192 billion (yuan, US$28.5 billion), and in fact, its net liabilities could reach 280 billion (yuan, US$41.5 billion).

Local debt is also a big problem in our financial market.

The National Audit Office (NAO) said that local debt was 17.8 trillion (yuan, US$2.6 trillion). Mr. He Keng, deputy director of the National People’s Congress’s (NPC) Financial and Economic Affairs Committee, said that 40 trillion (yuan, US$5.9 trillion) might even be an underestimate; it is more than 40 trillion; and no local government wants to pay off its debts.

The Stock Market Slump

I think it is still too soon to expect the recovery of the stock market (in China). Take a look at the situation. The only example (in history) that is comparable to the current stock market fall (we saw in China) is the 1929 Wall Street crash. In that crash, most stocks fell by 80 percent and some fell by 90 percent.

One of the questions we have to reflect on today is what caused the pain in the stock market?

Some people criticize the Securities Regulatory Commission (CSRC), and some criticize Mr. Liu (Chair of the CSRC) or someone else. I think those are the wrong targets. Regulatory policies are inadequate and may not be in place, and the stock market policies are not perfect. These may be important reasons but not the key reasons.

Take a look at our profit structure. The banking and real estate sectors took away 2/3 of the stock market’s total profits. The total profit of 1,444 small and medium-sized listed companies can’t even match the profit of an Industrial and Commercial Bank (ICBC). How can a stock market like this become a bull market?

We buy a stock mainly for the company’s profit not because of the speculative news. Yale University professor Robert Shiller said that the stock market is not the barometer for a country’s economic health in the short run, but must be in the long run.

Since October 19th, so many policy measures have been introduced. Vice Premier Liu He even came out himself to endorse the policies. What is the situation now? Last Friday, stock fell below 2,600. It has been around 2,600 since. When is the spring of the stock market going to arrive?

So, I think a stock market that performs so poorly can only indicate one problem: China’s real economy is in big trouble.

4. Financial Sector Derailed from Real Economy

Everyone knows China’s economy is slowing down. It all boils down to our model of expansion and growth in the past. The mentality behind such a development model contains a serious flaw: derailing from the real economy. This is what the former central bank Governor Zhou Xiaochuan said.

What are our financial risks right now? They are hidden, complex, emergent, contagious, and harmful. There are serious structural imbalances, and rampant illegalities, and violations of regulations.

It is necessary to prevent both black swans and gray rhinos. {2} A reporter once asked Governor Zhou (Xiaochuan): Where are the black swans that you are talking about? What are the black swans? Zhou smiled and did not answer.

A black swan sits right next to you. Aren’t those financing scams a black swan? But you just can’t see it.

Gray rhinos? Gray rhinos happen at any time. Block chain, Bitcoin circle, aren’t they black swans? The real estate market is the largest gray rhino.

Therefore, there are way too many such examples in China where we are drifting away from the real economy. In short, it is profiting from arbitrage.

At the National Financial Work Conference last year, the General Secretary and the Prime Minister seriously criticized China’s financial industry. They said that you are entertaining yourselves. The sector has derailed from the real economy and faces so many shocking and chaotic phenomena.

In addition to these financial arbitrage activities, where did most of the companies put their money? They didn’t invest in their core business. In the past ten years, IPOs have increased about 9 trillion (yuan, US$1.3 trillion), or more than 9 trillion. Where did 40 percent of the funds go? They went to stocks, futures, and buying shares of financial companies. They were not spent on the core business. Can a listed company be successful like this?

I also know many founders and bosses of the listed companies. Frankly speaking, quite some funds backed by pledges of stocks of rights were not used to invest in their core business. Where did they go? They went to the financial sector: financial instruments, or real estate.

According to the official data, the total size of speculative purchases of real estate by listed companies amounted to one or two trillion yuan. Therefore, the whole Chinese economy is hollowed out. Everything is leverage over leverage.

Starting in 2019, China embarked on this road of no return, with a soaring debt ratio. The leverage ratio of our companies is three times the average ratio of the US and twice that of Japan. The debt ratio of enterprises and the debt ratio of non-financial companies are the highest in the world.

Short-term Monetary Policy Cannot Solve the Fundamental Problem

Now that the pressure of the economic downturn is huge, the government has pulled out its old tricks again: easy money, an aggressive monetary policy, a loose fiscal policy and an aggressive capital policy.

Can these policies solve the fundamental problems in China? Our monetary policy this year was not stringent at all. We released 4 trillion yuan (US$0.6 trillion) of liquidity; 2.3 trillion yuan (US$0.3 trillion) was to pay the medium-term lending facilities (money the banks borrowed from the central government). Applying the money multiplier, 2.3 trillion (US$0.3 trillion) becomes more than 10 trillion (US$1.5 trillion).

There are “three arrows” related to monetary policy. They are known as “Governor Yi’s three arrows.” The first arrow is loans, the second arrow is debt issuance, and the third arrow is to solve the pledge of stock rights.

Therefore, we have to reflect on our current problems. Can our policies solve problems at a deeper level?

There have been so many policies introduced in the capital market. I don’t think any of them are really working. It’s been two months from October 19 until now. Can it work? Isn’t this worthy of our serious thinking? What are the root causes of our economic problems?

So, I conclude from my reflection that the problem of the current Chinese economy is not the problem of speed or the problem of quantity. It is a problem of quality.

The report of the 19th National Congress was well written. The report of the Third Plenary Session of the 18th Central Committee was also well done. Unfortunately, many of the policies have not been implemented. The structural problem of China, as well as the “six major imbalances” mentioned in the 19th National Congress, are more an issue of insufficient development.

Moreover, the short-term monetary and fiscal policy adjustment I am talking about here is unable to solve the “unbalanced and insufficient” development issue mentioned above at a fundamental level.

{1}, literally “Literature City,” a Chinese-language tabloid website.
{2} “Black swan” and “grey rhino” were first mentioned in a People’s Daily commentary published on July 17, 2017, the second work day after the conclusion of National Financial Work Conference. “Black swan” generally refers to an event that is unexpected, rare, hard to predict, and has major ramifications; “grey rhinoceros” refers to large and visible problems in the economy that are obvious but ignored until their disastrous effects become apparent.