 Andrew Zimmerman. Welcome to our pilot episode of China, Hawaii and you. We're very excited to tell you about this fascinating place in the east and how it's what's going on there affects us in the west and all those of us in Hawaii. So today I've got a really, really exciting guest that I really, really cannot wait to hear what he's got to say. You want to give yourself an instruction, Tony? Oh sure. Well, first of all, thank you very much, Andrew for having me on. And I assume most of your audience are North American based in Hawaii by the sounds of it. Yep. So my apologies in advance if they have trouble with my accent. I'm from New Zealand. So it's a bit of a funny accent at the ease in the A's New Zealand bed head. But I will endeavor to speak clearly. And if you can't understand something I say, I will do my best corny American accent to say it again. Thank you for having me on. In terms of my background, so I'm from New Zealand. I did my law degree in New Zealand. I worked briefly in public policy for the government there. Then I moved into private practice, mostly in corporate law litigation. But then soon after that I decided to move to China for several reasons, personal and professional. I moved to Beijing where I did a master of laws at Peking University. Now it was a master of laws, but the subject matter was not really related to law. It was more related to public policy, political economy and Chinese foreign policy. So that's what I studied there. Finished my masters and that was about six years ago. And for the last, I moved to Beijing six, six years ago. Since graduation, I've spent the last three to four years working in the private sector in China, mostly in project management and doing consultancy work on the side focused mainly on macro developments in China for clients based overseas. So yeah, that's a quick intro to my background and why you've got me here talking about talking about China. So the subject for today is a really, really interesting development that people have been hearing about. The markets are going freaking crazy when people think about a lot of Chinese companies. They think about Alibaba losing half its value in a day. They think about 10 cents supposed to be on the chopping block next. But a really big thing that has kind of made people think like, I wonder why my portfolio is looking a bit lighter today is the Evergrande crisis. And that's our big topic for today. And a lot of people have drawn strange, not strange, but really interesting comparisons to the Lehman brothers. Yeah, yeah, yeah. And for those of you with maybe short memories, the Lehman brothers was a massive financial institution that collapsed in 2008. And many economists today agree that that was really what kicked off the great financial recession in 2000. So we'll get to whether or not those comparisons are appropriate in a minute. Yeah, I think to lay some background, the first thing that I want to talk about is, you know, when people, especially when people think of communism or communist China, right, this is the reaction I got from my parents, some people can't even believe that there's companies like this at all, right? It's kind of a strange thing to, it's kind of a strange thing to Americans in the way that they hear about the term the word communism. They can't really, they think like, well, how is it possible that you have these private companies that even had $300 billion that that they could get into, right? How is it possible in a country like China? So could you tell us a little bit about how China has sort of from the original, from the original state in the Maoist era, kind of made this transition to where a company of this size being too big to fail was even conceivably allowed? Can you tell us about how that transition happened? I really like how you framed that question. You actually touched on a couple of main points there. So let me sort of change my answer to change the order of my answer because you touched on several main points there. So then hopefully there's a good framework because I think you touch on something really important here, which sometimes it's hard enough to understand a crisis in your own country. If it's a financial crisis or some sort of economic problem, if you're sort of regular Joe or Jane or whatever, and you see you're reading in the newspapers, there's this crisis. Sometimes that's difficult enough to understand in your own system, let alone in a completely different system and a different civilization, then it becomes complex. And so we need to have an understanding of the system we're talking about to quickly touch on your first point. China is in name a communist country. Many people say that it's communist in name only. That is not exactly correct. I would say the best to use Western sort of language, it's a mixed economy currently. It was heavily socialized, nationalized during the Mao and early reform, there were liberalizations through the 80s and 90s, large parts of the economy were liberalized, but large parts of the economy were also not liberalized. Downstream industries, for example, the sort of industries that manufacture goods for export that provide goods and services for the households and consumers, the property market, which is what we'll be talking about today. And some of these downstream industries are quite liberalized. Their prices are set by the market, supply and demand. There's capital that flows into them, but upstream industries like the banks themselves, the financial sector itself, like electricity production, like heavy industry, a lot of this is either completely state owned and state run or is heavily influenced or heavily regulated to the point where it's basically de facto owned. It's a mixed economy and it's much more, it's much closer to a state intervention and central planning side of the mixed economy than laissez-faire sort of mixed economy. But in terms of how we got here, the first point you brought up was this idea of the Lehman brother moment in China or the Lehman brother moment of the East. And then the first question is, when we try and understand this issue in the background that led up to this issue, the first question is, is this a good analogy? And in some ways, it's a sort of a useful way to start the conceptualization when talking to a Western audience or an Anglophone audience, like your audience. But it can only go so far. When it comes to our analysis of the problem, using that analogy is not very useful at all. In fact, it can be counterproductive. So how is it similar to Lehman brothers? Well, it's similar in that you have this very large company that became very over leveraged, that was acting in a very reckless manner. And now this company could be a trigger for a larger, either collapse or sort of an economic crisis, whether in the region or internationally. So similar to Lehman's in that way and that it's a large company trigger. It's also similar in the sense that there is what is highly likely a speculative property bubble at play in the background. But that is where the similarities really ends. And the reason why we don't really want to use Lehman's as a lens for examining Evergrande is because when we do that, what we do is we look at what caused the crisis with Lehman's in the lead up to the 0809 crisis. And then we use that lens to examine Evergrande. And if it doesn't fit the framework, then we come to the conclusion, oh, there's not a problem here. But that's not actually, that's not a good way of approaching it because the system here is different. The nature of the property market is different. The options that regulators have are different. The question that regulators are faced with is different. And the consequences for the Chinese economy and the global economy are different. Some people say, oh, X, Y and Z led to the collapse of Lehman and the financial crisis. Let's look at the China example. There's no X, there's no Y, there's no Z. So there's no problem. But just because there's not X, Y and Z doesn't mean there's not A, B and C. So that's what I'd say on that. In terms of how we got here, let's take a step back. And I'll give you as a quick walk through the last 30 years and sort of how we got to this issue and then maybe talk about how I like to frame this crisis because it is a crisis. And it does affect a lot of, it affects the Chinese and it could potentially affect the world, not just economically, but geopolitically. But it's important that we understand how it does that, right? So in the 1990s, reforms had been in place for at least a couple of decades. Deng Xiaoping's opening up reforms started in earnest after the death of Mao. Mao, of course, was the leader of the country during a period of great upheaval. And the economic system was very much Marxist-Leninist. There was one of state ownership. There were no entrepreneurs. There was no property ownership. It was very much communist in the sense that I think many Americans think about communism. The reforms were introduced. It was bumpy, but there was a lot of early success. In the 90s, there were the Deng Wei reforms. The Deng Wei were sort of where people worked. And historically, these Deng Wei or these work units had provided housing for workers. People had houses that were provided by the government. And because it was provided by the government, there was a massive, massive shortage of housing. If you look at housing, if you, if you want to look at housing in terms of what is demanded by consumers, there was all this pent-up demand. So in the 90s, the government reformed this area and they liberalized the sector and they allowed people first, initially, the Deng Wei houses were privatized. And so people who were already living in them were given the opportunity to buy them at a very cheap rate. And this started the process of lots of millions and millions of households getting assets for the first time. And because this unleashed a lot of pent-up demand, the prices of these houses were up very quickly. And so you had millions of people in the lucky cities where they were given the option to buy the houses, their wealth skyrocketed. And then they could use that wealth to actually consume. And then you had household consumption that kicked in. And this started a positive cycle, a cycle where you had increases in household demand. But you also had an economy that was just really needed capital and needed investment into infrastructure and needed to build cities and need to build houses. So you had the skyrocket of the skyrocketing of prices and of activity. And we know the story, China grew very quickly. At that time, from the first 10 to 15 years since the reforms of the housing market, many observers in the West, especially who were not China experts or were not trained in the Chinese system, they believed that what they were looking at was a massive bubble because the property prices had skyrocketed so quickly and to such high levels. But what they didn't understand was that because they basically started from almost zero, there was so much pent-up demand that those prices, even though they were skyrocketing, they were actually linked to fundamental demand. The fundamental demand was there for people to buy houses. And so the prices rose. Buying houses was popular. We'll unpack some of these ideas shortly. I just want to give a basic overview for your viewers. Property prices were going up. People were buying houses. Developers were entering the market. They saw a lot of money to be made and they were building houses. Now, this went on for about 15 to 20 years. Now, about 10 years ago, for reasons we can discuss, we can unpack soon if you want, about 10 years ago the price of houses at some point became detached from fundamental underlying demand and then entered into speculation territory. You saw the beginning of a speculative bubble. We can talk again shortly why we believe that is and why the government believes there is a speculative bubble in the housing sector here. And once you had a speculative bubble, if you have sufficient moral hazard, that bubble can keep growing. And so for the last year, that bubble has been growing and the price has become increasingly detached from the price of housing has been increasingly detached from fundamental demand. And this is sort of like the definition of a bubble, right? The asset price is higher than what it really, what its intrinsic value is. So that's the first step. You've got a popular asset in China property. It's been growing rapidly and feeling in a very stable manner because there was real demand. So people see prices go up. They buy houses. And for the last 10 years, though, it's teams that we're looking at a situation where you have a speculative bubble. The second thing is you have the entrance of these property developers, these big property developers. And because of a mixture of factors, property bubble, moral hazard, and the nature of the Chinese growth model, which if we have time we can discuss as well, because this is really key understanding the crisis that Chinese policymakers face today in Beijing, the nature of the property bubble, the property development industry grew very large and became incredibly over leveraged. So that's the second thing to understand. They've been growing for about the same amount of time as the property market generally, but this over leveraging has happened has increased dramatically over the last 10 years, mostly in response to the massive stimulus package that Beijing unleashed after the Lemons crisis back in 08 and 09. So that's sort of an interesting time with the real Lemons example there. The third step is that regulators in about 2018 recognized that the bubble was an issue. You have financial risk. There's a need to transition the growth model. Property development is too large a percentage of GDP. And so this is very dangerous because if you have a turn down in the property market, this can have a huge effect on GDP growth. And this is a wider social and political issue. And so there was need to regulate the market. And so regulators stepped in in 2008. And by the way, this was not just in the property sector as well. There was financial risk across the economy and other sectors. Technology sector, some of the gray rhinos that we read about a few years ago like HNA and Unbang and some of these. And so basically regulators in about 2018 made it harder for banks and other lenders to lend to certain companies. Now this had an effect in some sectors, it had an effect in the technology sector to some extent, but some of those large gray rhinos like HNA, Baoshan Bank, some banks, provincial level banks, they got into trouble. The government had to step in and take over some of the obligations, take some of the bad assets off their balance sheets and give them over to state-run enterprises. And they were sort of dealing with these issues on a case-by-case basis. But the property sector continued to grow. And there's several reasons why that happened and we can discuss that as well. But the property sector continued to grow until 2020 when regulators basically said, okay, what we did in 2018 is not working. 2020 rolls along. We're not going to go after the lenders. We're going to put regulations directly on these property development companies themselves. And so 2020, August, September of 2020, Beijing introduced its three red lines. And its three red lines were basically three ratios that property developers, they had to meet these ratios in terms of interest-bearing debt as a percentage of the assets on their balance sheet. This made it much harder for property developers to get the financing they needed. Actually, the first time I spoke on my show that I have, the first time I spoke about Evergrande was actually in September of 2020, over a year ago, because at that time there was a leaked document where a leader from Evergrande had sent a private letter to the local government, I think in Canton, Guangdong, and basically was saying, hey, if you don't let us list on the Hong Kong Stock Exchange and have access to more capital, we might not be able to meet our obligations. And this is going to lead to slow down and social and political issues. So it's almost like a little bit of a threat. And it actually just shows the level of interaction you see between local governments and some of these wealthy property developers. There's a lot of this what in the West we call crony capitalist sort of behavior. But that sort of leaked and it caused a bit of a stir. But it seems that the central government didn't blink. And they were like, no, you have to meet these requirements. And no, you're not going to be listed on the Stock Exchange at this point. So the situation continued. Evergrande, not having access to cheap credit anymore, having difficulty with financing and getting funding for its operations, it was greatly overstretched. It was incredibly over leveraged. It had diversified in a poor and disorderly manner. So it brought up assets that weren't exactly good that fits for the business model. There wasn't much synergy. There were buying assets across the country and overseas and projects overseas. It looks like they may have been buying up land that was just not a very smart move. And the operations could only be met by having access to credit. And when that dried up, they couldn't meet the obligations. And that's where we are now. When they couldn't pay those bonds, the payments that were due to bondholders, when they couldn't promise apartments being delivered on time for the over one million people that have purchased apartments off plans, when they couldn't pay billions of dollars owed to suppliers and service suppliers and good suppliers who are providing a lot of the inputs for their property, when all this happened, the government had to step in. And that's what we're looking at now. So I know that's a lot to sort of digest, but we need to digest it because it's so different. The nature of the system and how we got here is so radically different to what we would see in a more open capitalist system where a lot of things are very different. So we can we can unpack some of these points if you want, because they're also under they're also important. But what I will also say while you're here, sorry, I've sort of commented this part of the interview, what I what I'll say straight away to your viewers is there's this question of, will there be a collapse? Will there be a financial crisis? And more importantly, is it going to affect me in the West? Well, if there's a financial crisis, yes, it will definitely affect you in the West. It will affect the entire world. In the case of a financial crash, it would be like a real bad one and a massive economic a massive reduction in economic growth in China. This has two effects. The financial contagion spilling overseas is less likely because the capital market here is quite closed and the financial banking system is quite closed off. So there's you don't have the same sort of contagion you saw, for example, in the US with Lehman Brothers that quickly spread to Europe and other places because there was so much like so much of the system are tightly intertwined. So you don't have that same financial contagion risk. But in the event of a crash in China and massive reduction in economic growth and activity in China, because China consumes, for example, 50% of global commodities, if you're a commodity exporting nation, like Australia or some of these Belt and Road countries, then that's going to have a huge impact on your economic system. And so all these flow on effects, just the simple flow on effects of a the second largest economy in the world seeing reduction and growth will have economic consequences for the entire world. And that in of itself, once countries and systems overseas, which are more interconnected, see hits to their economic performance, this could this could trigger something larger. The what you would see would likely be not as bad as the crisis in the US in 08 and 09 simply because the US is the larger economy, it's larger than China. And what drives global growth is some debate to this, but I think most economists agree, what drives global growth is demand. Now China sees a lot of growth, but a lot of that growth is selling to Americans, because America has a lot of demand and American household consumption is much higher, it's like twice the size of Chinese consumption. So while you would take a hit, the US a crash in the US would be much more devastating to the world than one in China. So probably would not be as bad as 08, no, not except for the Chinese, it would be devastating to the Chinese, obviously, and to key trading partners. Now in saying that, the question, do I think there's going to be a crash? My answer is probably not. I think that it is unlikely that there is going to be a crash. Can I really quickly, would an evergrande crash, so let's imagine evergrande just completely default, right? How likely is that to, I understand it's not likely to bleed over into the rest of the world, right? But how likely is it to lead to a Chinese economic crash? Okay, so this is where I think it's useful to frame, to talk about, because evergrande is a symptom of a wider problem. There is a decision that policymakers have to make. And there's many aspects to this decision. But if we take a step back and really look at it in its purest form, or as an aside, I should probably, I think this goes without saying your viewers probably know this. Evergrande, one of the reasons why evergrande is a big deal is because it's so big. It has $300 billion of debt. And the assets on its asset sheet are probably not worth as much as it says on the asset sheet. In fact, a lot of them are probably worth nothing. That's why it's a big deal. It's huge. Yeah, I think that's actually, that's one of the big problems that people have in analyzing the situation, right? There's a lot of weird speculation about like, will they, will they run big crash? And there's a lot of different things you can look at. But at the end of the day, corporations and especially like these kind of financial firms don't tend to open their books for the public, right? And so for the most part, it seems like, especially when you're dealing with Chinese, Chinese financial giants, you're kind of firing in the dark whenever you make these, make these sort of forecasts. Sometimes, yes, that's the case. And that's why it's actually, and you're right, you're absolutely right. And people have been stung. People were stung with luck and coffee. People were stung with Diddy. People were stung with and financial overseas. I'm talking about Wall Street bankers who had money or plan to put money into some of these companies. And they were like luck and coffee, which was last year. I think that when a lot of the fraud came out with luck and coffee, a lot of banks and Wall Street lost a lot of money. I'm sure your viewers are not losing much sleep over Wall Street bankers losing money. But you know, it's just a wider point about sometimes it's difficult to know the true value of assets on balance sheets of these big companies. But also, even if they were very accurate, if you're, if a lot of those assets are property, and you're in a speculative bubble environment, then they're even if it's 100% accurate on paper, the fact that it's in a bubble, suggest they're overvalued at any rate. And in the event of a systemic collapse, then those prices collapse as well. And then you cannot sell them. And then you have a fire sale and it makes it even harder to get much for them. You can't meet your obligations. The reason why I think it's unlikely that Evergrande is going to cause a what now Evergrande may be cut up and and and it's met some of its managers may be arrested. Evergrande, I don't think if you if you have stock in Evergrande, I'm sorry to say, I hope you diversified because you're probably it's probably not going to be saved. Yeah. Well, the Evergrande sorry, I want to get one point in what's really strange to me about the Evergrande crisis, right? It's like what actually put it in the news is that is that they they were on the verge of diverting of defaulting on this massive bond. But if you take a look at the average Evergrande stock, right? It's like you reported this back in September 2020. But and I took it just to look at the stock price. And it's been on the collapse for the last year. Yes, 100%. So people who own the stock knew what was going on people knew from when you have a situation where there's a leaked letter where they basically say, hey, you need to give us cheap credit, otherwise it could cause a collapse. If you see that and you own stock in that company, you probably want to get rid of that stock. It's not a good look. So Evergrande by itself, we need to sort of make sure it's a tree in a forest. We need to take a step back and look at the forest. And it's a it's a very big tree. It's a very over leveraged tree. Definitely. And it could the what has happened with Evergrande and the sort of policy response that regulators will need to use in dealing with it could actually cause issues for the wider property sector. And that's important because it's so big. But what I'll say in terms of whether there's going to be a crash or not, Beijing has the fiscal space and has the legal and economic tools to manage the Evergrande crisis. In fact, like I said before, they sort of knew it was coming because they they use these regulators, these regulations to basically slow them down. So regulators were expecting this to happen. Now, if it is mismanaged, if it's mismanaged, it could trigger wider collapse. If regulators make mistakes, which there's a there's some people say that the Chinese government is super powerful and all knowing it's not the cases like any other government mistakes can happen, then perhaps you might have some sort of like systemic trigger that causes a wider collapse. If that happens, I think it would stem from part of these efforts from regulators is to use market discipline for the better allocation of capital. And so what they want is for the market to price and risk more more accurately when lending money to different to different actors in the economy. They don't want it to be based on moral hazard. They don't want lenders to look at a company and go, it's too big to fail. It's supported by the government. I don't care if they've got really bad fundamentals. I'm just going to give them money because I'm going to get it back. That's what they want. They want more market discipline and the allocation of capital. If the situation in terms of the rock under the floorboards was much is much more worse than regulators expected, then this could be a nasty shock. Perhaps they expect maybe like financing for some industries, it becomes harder by say like 10%. But if it actually becomes harder by 30 or 40%, then that could cause some shock. The other big wild card is the price of property in China. Actually, that's one of the big things that I wanted to talk to you. I really, really wanted to talk to you about is the price of property in China and kind of how it affects the rest of the world because not a lot of people in the West kind of fully understands the there is external factors to why it's important to buy a house in China. It's not just the classic thought of like, okay, well, now if I'm paying my mortgage, at least I'm building personal equity. People don't necessarily have this financial calculus when they're buying a house in China. Of course they do, but one, you never really buy a house in China. There's 70 or rental leases. Two, the reason that you're buying the house more often than not is so that you can get married. That's right. You're absolutely right. I really do want to jump into that, but we're going to have to take a really, really quick break and bring this into a part two. Before we let out, I wanted to ask, do you want to take a second to talk about how if people are really interested in what you have to say, where they can find you? Well, I have a small, if you know, for years I did consulting on the side, but then I thought I really wanted, I felt there was a lack of voices. It's good to actually see voices like you, to be honest, it's wonderful. I thought there was a lack of voices that made following China accessible. And so I recently started a YouTube channel called China Update. China Update, it's quite small. So if you search for it, you need to go to the filter and filter for channel and then search China Update and you should find my mug on the logo. Very excited to talk to you in a part two. And for now, we're going to say to our listeners, thank you very much for tuning in and we hope to have Tony back in.