Introduction

Yap Chuin Wei:

Good morning, everyone. No, we're online, right? I... Morning, everyone. Welcome to the Hinrich Foundation Book Talk. We're having, this Book Talk today with, Dinny McMahon, who's head of China and markets research for Trivium, based in Chicago, hence the timing of today's talk. I am Chuin Wei Yap. I am research director for the Hinrich Foundation.

We are a philanthropy that is dedicated to the mission of advancing global trade. We have two programs, one is education and one is research. And this Book Talk series is a collaboration of both our programs. I wanted to introduce Dinny, who is a long-time friend of mine. Dinny wrote a book, it's been a while now, it's called China's Great Wall of Debt.

He wrote it at a time, 2018, toward the end of his, well-starred career at the Wall Street Journal where he was a finance correspondent based in Beijing and Shanghai, in the Wall Street Journal, for people who know. When you are called a finance correspondent, what it really is, is that you're a correspondent for everything. So it was banking, it was finance, it was macroeconomics and it was, like, whatever.

And then he had a, had this, you know, way of just, he seemed to like cities with nobody in it. Which I'll tell, you know, let him tell you more about. At the, Hinrich Foundation, we, cover trade. Obviously. And we look at FDI, we look at geopolitics and digital trade. Sustainable, as well as trade policy. Of course, a central character in all of this is China. So today, I'm... we're going to be talking to Dinny about China's economy, its, latest five-year plan kicks off this year.

Robotics is actually a huge focus on it. Dinny has addressed some of it in a paper that he wrote for us, which was on the changing nature of China's exports there's an export surge coming from China. Dinny also addresses some of that in the paper that he wrote for the Hinrich Foundation. And we also want to talk about China's structural weaknesses, its struggle with consumption and the subject of Dinny's book, which is his debt-fuelled investments.

Leading to China's ambitions in a global order, how that has changed with geopolitics and challenges to multilateral trade. But, you know, first, you know, back to Dinny's book. Dinny's book, for those of you who haven't read it, opens with this beautiful description of Paraburdoo, which is, I've never been to. I mean, Dinny obviously has. He's Australian, by the way and but I also want to start, you know, at the end and I hope Dinny will talk a bit about Paraburdoo both.

Where he closes with a place perhaps just as remote to some of us, Bridgetown, Tasmania, where he met a family called the Ravenses and tells an anecdote of how... their lavender teddy bears, called Bobby, became really, a symbol for, China's market It's huge, the allele and potential of its huge consumption... well, sorry, slash huge. And really, you know, the comment that it makes on, income issues in China, Public expectations, which is something that nobody really talks about very much and a social contract.

Between... the Chinese state and the Chinese people. But Dinny, I'm not going to hog the microphone very much anymore. I'm going to turn it over to you. Thank you so much for being with us this morning. Well, this evening for you in Chicago.

Dinny McMahon:

No, not at all. It's fantastic to be here, Chuin Wei. I was very excited when you invited me.

Yap Chuin Wei:

No, we're very glad to, to have you. It's, you know, I've been a big admirer of your work, even back in the journal. So tell us about Paraburdoo. Well, tell us about, you know, your... yourself, your... how you got to write the book. What made you write the book? And as you very kindly offered, you know, during, you know, it's your thoughts on how things have changed since. And what China was and is today.

Big Idea & Origin Story

Dinny McMahon:	There's two kind of reasons or two arcs that sort of explain why I wrote the book. The first was, on one level, the book was an incredibly cathartic experience. I mean, you know, during that period that we were at the Journal, I mean, at Dow Jones for me and the Journal, I mean, I spent 10 years working as a financial journalist in China from 2005 to 2015. You look back at that now, that period, that decade-long period and it was a golden era. I mean, in terms of... I remember when I first started, it almost felt like it didn't really matter what you were doing in China, you just... felt as though you were at the center of history. I mean, it was just instinctive, it was visceral. And you look back now and that really was a golden age to be living in China as a foreigner, you know, in terms of the experience, in terms of the pace of economic growth and I think also in terms of the potential of what China could become and would become. It seemed both open-ended and preordained at the same time. You know, the future was bright, if nothing else. And so I wrote the book for a couple of reasons. One is because as a journalist at that time, I mean, one of the... look, it was fantastic writing for the journal, but also one of the great frustrations is that you never got to write more than 2,000 words. You know, a generation before us could sort of go out to the countryside and come back with, like, a, you know, a 5,000-word, you know.
Yap Chuin Wei:	No, no, cut that, cut this.
Dinny McMahon:	So, we had so much. Sometimes some of our best material was left on the cutting room floor.
Yap Chuin Wei:	So much.
Dinny McMahon:	So... too much. And so, after a decade, it was kind of... One, I had all this material, but there was also a sense of what you were saying before, we end up covering so many disparate, seemingly unrelated stories, but after a decade, I kind of felt that there was a sinew, there was a... something connecting them all. And in some ways, that was kind of what led me to writing stories about ghost cities, about overcapacity and about efforts to break down industrial monopolies. They all seemed to be linked on a certain level, but we never really had the bandwidth to kind of, you know, pull the thread and work out how they were connected. So, on one level, writing the book was a cathartic experience because it gave me the opportunity to sit back and try and work out what the broader, overarching narrative was here. And of course, part of it as well is, you know. after that amount of time in China, your notebook is sort of filled with these absurdities of how the Chinese economy actually works from the ground up. You know, this situation where, you know, policy is imposed top-down and yet the way that it's imposed, the way that it's implemented, or the way that it's twisted, or the way that it's sort of... you know, people get around it at a local level. It's the sort of thing that's difficult to write about, it doesn't really turn up in the mainstream coverage of how China's economy works. And so, on one level, there was this sort of urge just to kind of get that out there. It's like, you know, the working of this massive economy is so much more complicated than you really appreciate when you're kind of sitting on the outside. So that's kind of the first reason I wrote the book, but there's also kind of a longer arc to how I ended up writing this thing and it really relates to what you were saying about.
Yap Chuin Wei:	And it arrived in China which year?
Dinny McMahon:	Well, as a journalist, I started working in 2005, but I'd already been there studying for a year, I was a foreign student there in 97, I was there again as a student in 2001, so I'd be... by the time I started working, I'd already studied there for 3 years. But, the other reason I wrote this, as I said, relates to Paraburdoo, is I had my first Chinese lesson when I was 10 years old or about 10 years old. Which is not unusual anymore in Australia, but at the time was incredibly unusual. And it was because my dad, had spent most of his career... well, he spent his entire career working for Australian mining companies and Rio Tinto in particular. And by the time I was born, like, he'd... you know, before I was born, he managed... he worked on mine sites, he managed mines, he built Paraburdoo in Western Australia, you know, it was a....
Yap Chuin Wei:	But before that, we should explain to the listeners what Rio Tinto is. They might not know.
Dinny McMahon:	Oh, of course. sort of Rio Tinto being one of the two big, I guess, Anglo-Australian mining companies, along with BHP. You know, they're most known for iron ore, but at this point, it's very much a, you know, a diversified, you know, mining company. But Parabadoo, which is, you know, my dad worked back in the 1970s, sort of built the mine from the ground up. Was an iron ore mine. And so, by the time I was born, my dad was working in head office and was traveling around the world a lot and in his experience, and this was in the late 1970s... oh, sorry, by now it was in the early 1980s, he was sort of finding that as he traveled around the world, he was coming across Chinese buyers. more and more often. And of course, this was a time where, you know, the sort of number two global economy was Japan. Anybody in Australia who was learning a second language was learning Japanese. And dad came home one day and said, you're gonna learn a second language, everybody else is learning Japanese. Actually, what he said is, the Japanese speak English and that you should learn Chinese. And that... set me on a path. I studied Chinese all throughout high school. I... finished high school, I went over to Beijing, studying for a year and then through my degree, I went back again, I finished my degree, I went back again and then I started working as a journalist. And so, in some ways, writing the book was kind of the culmination of kind of a... almost a lifetime of trying to learn about China, struggling with the language and just trying to work out its place in my own life. And in the end, what we ended up with was China's Great Wall of Debt.

Chinese Consumption and the Middle Class

Yap Chuin Wei:	Right and you know, for anyone tuning in, let me tell you, you're not... you weren't struggling with Chinese. I mean, Dinny, Chinese in some respects. particularly with policies, is better than mine. I mean, he's just one of the most fluent Chinese speakers that I know and it's... it was always sort of... jarring to me to hear you open your mouth and speak Chinese and then to hear the... and then to look at the expressions of the... of the, Of the locals, around. But let's, let's circle back to the Ravenses, in Tassie and what this says about consumption dead and consumption now in China.
Dinny McMahon:	Yeah, that was, you know, it was a fascinating story. I mean, when Xi Jinping visited Australia back when, was it 2013? I can't remember what year. But he went to Tasmania, right? And it's mind-blowing to think that the leader of China, like, no offense to Tasmania, beautiful part of the world, but it is, you know. It's not particularly economically significant, it's very small and the idea that the you know, the president of China should turn up to Hobart Airport is, you know, it's a little bit off the beaten track, to put it mildly. And when he arrived there, he was presented with a lavender-stuffed teddy bear from this farm. It was an absolutely, absolutely a phenomenon. And I think what I found fascinating at the time, well, probably more with hindsight, just trying to work out why this thing was so popular because, you know, the Ravenses who ran this farm, they were like, look, this is an affordable luxury. But on one level, I mean, these bears were really expensive. You know, people were buying and selling them on Taobao, it was a few hundred dollars. I think it even got well beyond that at some point.
Yap Chuin Wei:	Hunter.
Dinny McMahon:	And so it was... yeah, it was...
Yap Chuin Wei:	That's one of these things weren't cheapest.
Dinny McMahon:	Yeah. These things weren't cheap at the end of the day. And, I think it was less about it being an affordable luxury and I think we went through a period, particularly in that golden era that I was talking about, where not only were incomes rising in China, but, you know, you had a relatively strong renminbi. Which I think, in some ways, acted as a subsidy for China's middle class. Now, of course, it could have been stronger, but it was the strongest it had ever been and you had this situation where it wasn't just people going to Australia and buying lavender-stuffed teddy bears. You know, you had this wave of Chinese people, increasing numbers, going to study abroad in Australia, the United States and the UK. More and more people were taking international holidays. When they took international holidays, they would take, you know, a second suitcase and depending on where they were going, they would buy up big consumer goods. It would be, sort of, children's clothing in the United States. It would be luxury goods in Europe. It would be... electronic goods in Japan are be cosmetics in South Korea. But there was this moment in time where people were traveling, they were going abroad and they were buying stuff while they were abroad. And it wasn't isolated. And I think these days, we look at China and we see how... much of a challenge, getting consumption growth to even get up to the pace of economic growth is. I mean, consumption growth has lagged since the housing market has peaked. And I think one element of that is the middle class in particular has seen their wealth massively eroded by the collapse in housing prices. But, I think it also has something to do with the currency because people no longer find it cheap to go to the United States to have a holiday. And although the renminbi has, you know, weakened a little bit, hasn't weakened that much, but since COVID, you had this you know, sort of divergence in prices between the United States and China. So it doesn't necessarily show up in the exchange rate, but it does turn up in the lived experience of people paying at the cashier in both of those countries. So whereas in China, we've had, effectively, deflation or minimal consumer price inflation. In the United States and everywhere else in the world, prices went up and of course, incomes went up, if not accordingly, but, you know, more or less in, you know, as prices went up. And that impact, that divergence has meant that it's no longer cheap. For China's middle class to go abroad and do what they were doing a decade ago. You know, it's no longer... is something that... they can't sort of fly to Tasmania and, you know, go to Australia, deliberately go to Tasmania to visit a lavender farm to buy up on the lavender stuffed teddy bears. That sort of equation... the economics just don't make sense for as many Chinese people anymore and I think it's tied up with deflation, inflation and the currency.

The Export Surge and Industrial Upgrading

Yap Chuin Wei:	So... As part of the response, is, is a sort of doubling down on exports. And, we talked a little bit about this in our past chats. One of the reasons for this, you know, I think we, we, sort of set, you know, both, think this, that this is, true is because they don't really have any other choices, I mean, policy-wise. Doubling down on exports is, is the way, perhaps the only way of the housing market, being the way it is, which actually speaks to something that actually panned out to be quite true in your book, although... But, talk a little bit about what the Chinese are doing now with the current surge, of exports is a little bit different. You've posited, right? Could you talk a little bit about that? as well as, the... The housing market and the exchange rate, well, those are... those are two secondary subjects, we can circle back to that. But, the export surge, you know, how is that a response to the economic problems that China is facing now?
Dinny McMahon:	Yeah, I think it's worth saying, look, as you said a minute ago, they're relying on exports because they don't really have many other choices. And I'm sure people listening to this would go, yeah, yeah, but what about consumption? I mean, it's so weak, why don't they do something to boost consumption? And these two issues are intrinsically linked because they are leaning so much into, you know, into exports because they're not willing to boost consumption. And the reason is, I think, you know, China's leaders have been talking about the need to you know, for consumption to play a greater role in the economy for a long time and they continue to do it. I think the issue is, though, that when we hear them say that outside of China, we assume that they're talking about wealth redistribution efforts because at this point... Oh, sorry. Wealth redistribution.
Yap Chuin Wei:	Well, right.
Dinny McMahon:	Because we look at it and we're like, well, look, the only way people would reasonably be able to spend more is if money was put in their pocket. But that's not what Beijing is talking about. I mean, clearly, Chinese officials say all the time they do want to spend more money on public services and welfare. I mean, there is this idea that Xi Jinping doesn't like welfarism. Sure, he doesn't like people getting something for nothing, but he does talk a lot about the need to spend more on healthcare and on eldercare and on childcare. And all these things, if China spent meaningfully more on, could reduce the emergency savings or the anticipatory savings of China's public. They save less, they spend more, ipso facto, you've got a more consumption-oriented economy. But they're not doing that, even though they say all the time that they'd like to. And the reason is, they don't want to fund that expansion of welfare or of public services with debt. They say it all the time. They say, we need to be able to spend more on these things, but within our means and within the ability of the economy to support it. So we're in this strange position at the moment, sort of post, you know, you know, property decline, that tax revenue is incredibly weak. And so, even though China's authorities might have this incentive and goodwill and genuinely would like to spend more on all this stuff that might put more money in people's pockets. the fiscal situation does not allow them to do it. They could borrow and reallocate that wealth, but the way that they see it is herein kind of lies the road to damnation because once you start spending more on welfare, you can't back out. You do it this year, you gotta do it next year, you gotta do it the year before and all of a sudden you're in a sort of a spiraling sort of debt trap, which they refer to as being Latin Americanization because they look at Argentina and Brazil in... what, the 80s, 90s and 70s? And they sort of see that as kind of what tripped up those economies. And so that's the first part. a consumption-led economy isn't really a solution. And so, neither... what they're really left with, because they had an investment-led economy with the property sector, so that's not really an option anymore, now that it's peaked, now that the population is shrinking, that leaves exports. And of course, the approach to exports this time is a little bit different as well. Because what they envision, what they really want, isn't just an economy that is churning out low-end, mass-produced goods. What they want is an economy that's producing significantly higher value goods. And the reason is, you know, things that they've designed themselves, things that are the result of local innovation because those sorts of things allow them to Generate higher profits. If you have more profitable firms with higher profit margins, that supports higher wages, which supports a bigger tax base and it's that combination which sort of allows China to continue... Chinese living standards and wealth to continue converging with that of the United States and the EU, gives the state the resources to spend the things that they want. And so you've kind of got this razor focus on raising productivity through industrial upgrading and innovation. And what that's resulting in is this sort of massive expansion of industrial capacity But the domestic Chinese public isn't able to consume it because domestic demand is so weak and so it ends up flowing overseas. And so that's kind of where we are at the moment. It is a very specific vision of future Chinese growth has to come from productivity gains, through innovation and industrial upgrading. But the only way... the only buyers available for the output of all that is overseas, not at home.
Yap Chuin Wei:	Right and that's gonna... And that is the structural weakness, that is the structural sort of contradiction, I think, rather, that they're struggling with. There's so much of the dependence Of that growth is on markets that are increasingly unwilling to take that... Too. And I know you've finessed it in your arguments because... We talked about how the type of exports that China is now focusing on actually may find its appeal in places where you might not expect. But it is that inability of people at home to buy it, that also creates that problem. With the fundamentals of social... Contract that, you know, there's a sort of, myth that... the Chinese government, is, you know, a one-party state is forever. But there is, a sense of social contract there. It's interesting... when, you talked about, this guy called Zhu Shanging in, which, which town was it? Was it... it's, it wasn't Tienel, it was.
Dinny McMahon:	Hangzhou? It was outside of Hangzhou, I think.
Yap Chuin Wei:	Yeah, this incredibly colorful character with blue suede shoes, as Dinny described in his book and Crystal Champagne, which is unfortunately not for you. And, something to do with white ducks. And, and there's this quote that he just threw out at you, which, we just took down, which is that it is not just difficult to grow. It's difficult to survive in China. Was what he... He said to you. In the light of, you know, that anecdote and including it in your book. And looking at the situation today. What does that... what does that say, you know, in light of your comments on competition in China. economic life in China, And that... I guess social contract is one way of putting it. Which, in a way, you sort of touched on when you talk about tax, you know, that tax authority because I think at the central and the local level, there's this... There's a tension that, that, you know, it just seems impossible to resolve, there's a whole bunch of issues in there, but I don't know whether there's a sensible way for you to tie it all together to address.
Dinny McMahon:	Yeah, the, let's start with the competition question and see if we can tie it a little bit into exports because that guy you were talking about in particular, he was a textile manufacturer, specifically spinning yarn and then making fabric. And, you know, he was moving from Hangzhou and setting up a factory in South Carolina. And what I find really interesting about that particular industry is that, traditionally industries like that, which we typically think of being as low-end, at this point in China's economic cycle, they should be either... they should be moving out of China. And that's one of the reasons he was moving to the United States in the first place because spinning yarn Isn't a particularly labour-intensive industry or it's becoming less and less labor-intensive. In fact, these days, in a lot of factories around the world, you don't really have people you know, in the factories at all. The entire process is automated, right down to sweeping the floors. You effectively have industrial Zumba, you know, keeping the dust down. You just have people... I know in some factories in China, you just have people, you know, riding around with iPads and Segways, making sure all the computers, all the machines are working properly. And so he was moving to the United States because he found that you know, the cost of energy in the United States was cheaper, the cost of land in the United States was cheaper, the cost of cotton in some ways was cheaper because there was a quota system in China, you had to buy local cotton first before there could be imports and it was just easier for him to sort of be closer both to the supply of cotton and close to the end user. And so, he was moving to the United States because, sure, labor in the U.S. was more expensive, but everything else kind of worked out cheaper. And it's a really interesting industry because Beijing has effectively said over the last few years that I think it was the head of the NDRC explicitly said, there are no low-end industries, there are just low-end technologies. And so we're in this really strange moment where these industries, which would traditionally have moved overseas, either back to the United States for the reasons I outlined, but, you know, in labor-intensive manufacturing. In East Asia, I know when I was at university, we, in the 90s, we got taught the flying geese model of development, whereby, you know, as a nation developed, lower-end manufacturing would move somewhere else when you know, where the labor was cheaper and in order to maintain its cost advantage. And that's where China should be at the moment and Beijing is explicitly saying, no, we're going to keep all of those industries. And the way that they're keeping them is with technology. So you have this, you know, you have, you know, engineers and designers and PhD higher up the value chain, designing more advanced machinery to be able to keep these industries in China. With far fewer workers. And so, a classic example of this is, manufacturing of cigarette lighters in a town called, I think it's called Shaodong in Hunan Province, makes something like 90% of all lighters globally and it was facing the same problem as this yarn manufacturer, I think starting in 2016. It's just wages were going up. They couldn't keep their employees and they couldn't keep prices down at the, you know, low enough for what their international buyers were demanding of them. And so, they started upgrading their production line. And I think they've been through something like 5 or 6 rounds of, you know, industrial upgrading over the past. well, decade or so? And so we're now at a moment where, over that decade. you got some of the biggest producers, employ, I think, 95% fewer people and the cost.
Yap Chuin Wei:	95% fewer people.
Dinny McMahon:	Has been movement to Southeast Asia. But in terms of this... putting aside trade restrictions, the economics of these industries are changing as China tries to make them more capital intensive, make them more profitable and as I said, labor is declining and this is where things kind of get really... Interesting, it kind of comes back to your question about the social contract. If you look at, sort of, the labor data over the last few years, the number of... the percentage of people or the number of people employed in manufacturing, it fell a little bit, it rose a little bit, it's And the cost of manufacturing a lighter is 85% less. And so, you've... this is kind of what Beijing is striving for. It doesn't want to keep low-end industries to maintain... labour, it's not a safety net for keeping people employed. If anything, maintaining lower-end industries is to be able to provide a market for the higher-end manufacture and design of capital goods and also to be able to have the full production chain to be able to innovate along every sort of step in that process, in a way that places like the United States... in the United States lost because so much of their low-end manufacturing has kind of moved overseas. And so you've got this very strange... we're in this very strange moment where the industries we've traditionally thought of as being low-end and ripe to move out of China are mostly only moving out to get away... to get around trade restrictions because there basically stayed stable. even though we've had trends like what we're seeing in the manufacture of light is, that's because China is expanding into more, you know, advanced industries as well. But to the extent that Beijing has kind of a... a labor solution or has a vision for how this process will result in more jobs. It's focused not on manufacturing jobs. Even though, it's focused on manufacturing expansion, it's focused not on manufacturing jobs, but on white-collar jobs. And a great example is, you take a company like Apple, right? Apple employs 90,000 people in the United States and employs none of them in manufacturing. You know, China... Apple doesn't make anything in the U.S. but most of those 90,000 people have relatively high-paying white-collar jobs. They're, you know, designers, software engineers, PhDs, supply chain managers and lawyers protecting IP. And that's what China wants for its economy. You know, any high-end manufacturing firm which has robust profit margins is in a position to spend a lot more on advanced business, white-collar business services. And that sort of That's the... that's the vision. And that is kind of really important because you see these tens of millions of kids graduating from university each year and at the moment, they come out and the jobs they were promised or the jobs they think they were promised, don't exist, but they might. If this, you know, if this happens. Now, of course, Al might throw all this, you know, throw a spanner in the work with all this, but that's a different story, but yeah, that's... that kind of speaks to the social contract, you know, the low-end manufacturing, what it means for exports, so, yeah, a lot going on there, but...
Yap Chuin Wei:	Yeah, what's the read on China now. I mean... What you've described sounds... Like, it's riddled with, really quite high risks. What's your read on China now? I look at a 55-year plan and... And all I see is robotics, right? I mean, I think the term Al appears, like, 15 times... I'm sorry, 50! More than 50 times, What is your read on China, both as an analyst. And in light of all your experiences.
Dinny McMahon:	You know, it's tough because you're right, I mean, they are so razor-focused on tech, innovation and industrial upgrading, that is the future, as far as they're concerned. And I think one of the reasons. They're so focused on that is because they're overtly aware that demographics are not in their favor. You know, they're dealing with a shrinking domestic population. You know, the only way you're going to be able to raise incomes in an environment where, you know, fewer workers are supporting a much larger population of retirees. I mean, ultimately, what they want is to be able to raise everyone's income. You know, so it becomes a more affluent nation. But that's incredibly different... difficult when your working-age population is supporting... there's fewer and fewer workers supporting more and more retirees. Ultimately, you need a system that allows you to be able to tax the workers more. And yet, they still feel better off. So their incomes have to be going up, even as the state is sort of extracting more and more out of them. And I think, in some ways, that's why... at least from an economic perspective, rather than a securities perspective, but I think from an economic perspective, that's why they're so focused on tech and innovation because they see that as the only way out of the middle-income trap, the only way to keep raising, wealth and incomes, even as demographics move against them. So that's my take on what they're trying to achieve, but of course, there's sort of layers of complexity here because You know, domestic, you know, you've had people, you know, so much of... Making that a success, relies on the rest of the world buying more and more. Not maintaining levels of consumption, but the rest of the world buying more and more of what China produces. And given that, you know, back in the day, back when we were journalists, I mean, there was the argument that, look, you know, China has a massive trade surplus, but it'll eventually work itself out because you'll kind of get to a point where the economy will restructure, the rest of the world can only absorb so many exports from China and then it'll restructure into something that looks more like an advanced economy. And it seemed mind-blowing to think that an economy the size of China could pivot and start to extract further growth from exports. And that's what happened last year. I mean, the... I think a third of China's growth came as a result of exports, which is mind-blowing for an economy the size of China. And so, it is so dependent on the rest of the world buying its stuff. Which is both a, you know, it's a vulnerability, but it's kind of sort of baked into the system at the moment. And then meanwhile, as I said, you know, domestically, they're not willing to redistribute wealth by using debt and there don't really seem to be many other options available to them, so they're kind of waiting for the housing market to bottom, at which point maybe home prices will start going up again. They're very invested in trying to revive the stock market, but this time, rather than sort of manipulating it in the way that Beijing has traditionally done, it's a lot more about sort of building a foundation of trust and sustainability and hopefully that will be an engine of middle-class growth. But then at the same time, you have this sort of massive debt overhang at a local government level. Beijing is refusing to borrow... to bail out local governments and so, you know, this was... you've effectively got austerity policies at a local government level, which is effectively continuing to drag on growth. So you've got all these, sort of. you know, challenges. You've got the debt, you've got demographics working against them. You've got the over, you know, the problems of, you know, the property market and then you've got this razor focus on, you know, the future you know, of Chinese prosperity can only be delivered by innovation, industrial upgrading and productivity. I mean, you know, it's... I'll make one other, you know, comment before we sort of move on. For this vision of industrial upgrading, productivity and, you know, innovation to be a success along the terms that I just described, alright? That it will deliver a more prosperous China. Three things have to happen. It needs to result in more profitable companies, companies with higher profit margins. It needs to generate higher-paying jobs, right? And it needs to expand China's tax base. It doesn't need to generate more tax revenue, it needs to generate more tax revenue relative to the size of the Chinese economy. And last year, none of those happened. Alright? First half of last year, tax revenue actually fell, which is mind-blowing to think taxes contracted in a year that the economy was nominally growing at 5%. I mean, full year it went up 0.8%, but there's reasons for that. But an economy is growing at 5% and yet tax revenue is barely moving at all. Corporate profits, exactly the same thing. Corporate profitability, I think, increased 0.6 or 0.8%. we don't have the same measures for incomes, but, I mean, you spend any time in China and people talk about how they're worried about their own wealth because of the property market. Everybody knows somebody who's either, you know, lost their job or more often than not, had to take some sort of pay cut or they didn't get their bonus or something. And so, you know, sitting outside of China, we see this economy that's going absolutely gangbusters, in terms of. Selling abroad, more innovative products, you know, solar power... you know, solar panels. And You know, you know, electric cars and, you know, on the horizon there are flying cars and it looks like, wow, China's, you know, China's delivering the future. And yet, domestically, no one's actually really experiencing the benefits of all that because that model isn't delivering what it's supposed to yet. Now, the question is whether it can or not and I think that's the tension. They've got a vision of what the economy needs to look like, but at the moment, it's not paying off.

Local Debt, Austerity, and the Financial System

Yap Chuin Wei:	Yeah, that point on taxes, fascinating and. I don't understand... why it hasn't gone up. Just to sort of, you know, explain, maybe. The fiscal structure in China and maybe, Dinny, you can do a better job at this than I can, is it has a real tension between central and local because a lot of what the localities raise, they have to give to the central government. And therefore leaves the localities with very little tax base and they used to depend on land and debt, the issuance of debt, as a way to fund themselves, which ended up in that, problems that Dinny writes, about a lot in his book. One thing, we had a question here, asking from Rita. Can we have a summary of the book, which, I think, you sort of addressed at the start and the takeaways which, this talk is all about. But maybe, you know. What did you, you know, you suggested this question to me yourself, what do you feel you got wrong in the book?
Dinny McMahon:	Yeah, so when I was... I think one of the great challenges when I was writing this thing was to kind of come up with conclusions because as I said, it was... as much as anything, it was a cathartic experience. It was, like, pulling the threads together. Trying to explain what I saw. And when it was... I was left with the question of what comes next, I was kind of scratching my head a little bit. I mean, in hindsight, what I realized I was writing about was kind of the final days of China's last growth model. Now, it's funny, as you said, that the title of the book is the China's Great Wall of Debt, but the tagline was, Shadow Banks, Ghost Cities, Massive Loans and the End of the Chinese Miracle.
Yap Chuin Wei:	Metrobanking, those cities and... Right. Okay.
Dinny McMahon:	And I remember getting a question at some point. Someone asked me, so, when do you think the miracle's gonna end? And I'm like, oh, it's not a prediction. It's a statement of fact. The miracle is already over. What we're witnessing are the dying days of the Chinese economic miracle. And it's funny because I do look back on it now and it's like, oh yeah, that's exactly what was happening. This was the last days of a completely unsustainable economic model, which had been, in the early days, was, shit, genius. I mean, to leverage the demand of the public for housing and for new infrastructure, you know, bringing urbanization, bringing people from the cities, I mean, it was an incredible motor of growth. But by the time you got to 2016, 17 and 18, I mean, it was all over but for the screaming. And the screaming finally started in 2020, 2021, when they pulled the plug on the property sector and all of a sudden, it became clear it wasn't sustainable. But I'd say the one thing I got wrong, was one of the few predictions I made was in my chapter about the financial system. I was like, look, this thing has to end in tears. I don't know when it's gonna happen, but at some point there needs to be a financial crisis. Because what I was looking at at the time was, you know, Beijing had completely lost all control over the financial system. I mean, every time regulators rolled out some rule to rein in shadow banking. The system just immediately slipped into gear to come up with a workaround. I mean, I remember at the time talking to a guy who was designing wealth management products at one of China's big banks and he was like, oh yeah, we've got, you know, 3 or 4 different alternative versions of, you know, alternative ways we can structure these products, so if they ban this one, we're ready to go the next day with a workaround. And that was the system, right? everybody was complying with the letter of the law, but everyone... the financial system was also flouting the spirit. And I think what I didn't anticipate was... two things. Firstly, I just thought that the complexity would get worse and worse and it would result in a crisis. What I didn't anticipate was, when Xi Jinping's anti-corruption campaign came knocking for the financial system. And what happened then is that idea of, you know, complying with the letter and flouting the spirit, that got flipped on its head. You know, it then became less important to be complying with the letter of the law, what became important was to complying with the spirit of what was being asked of you. And if you weren't complying with risk control efforts, then you were potentially on the out and you were sort of exposing yourself. And so, very quickly, starting in about 2016, 2017, they managed to rein in financial risk in China's financial system very quickly, very effectively, to... Today, where, I mean, you look at China's financial system and more, you know, it's more or less relatively safe. We don't look at it and go, oh, there's going to be a financial crisis. If anything, the regulators seem to be incredibly on top of the situation. Now, what we...
Yap Chuin Wei::	We needed at the IMF, by the way. think that it's, near a crisis. But go on, sorry.
Dinny McMahon:	So, what we ended up with instead of a financial crisis and it was something no one was talking about, but it's the obvious corollary, right? If you can't pay If you can't meet your financial obligations, if you can't repay a bond or pay the interest on the bond, you either default and ultimately that... if it's the wrong sort of debt, that potentially ends up in a... can trigger a financial crisis or you pursue austerity policies. You rein in your spending elsewhere so that you can pay the interest on the debt and that's what the UK did and that's what Greece did, but we never assumed that would be something that would happen in China. And yet that's what happened in China. Except it wasn't imposed top-down by Beijing, it was the response of local governments to their own financial stress. And that's what we've had over the last few years and it's been a drag on the economy, both on household sentiment and on business sentiment and it's just been sucking money out of the economy because local governments, are under pressure to make sure they don't default. There have been defaults, there have been defaults on shadow banks and various other stuff, but the important defaults on the bond market, the local governments have always ensured that they always meet those obligations. And so, to make sure the money's always there, even as Beijing asks them to spend more on science and technology and more on education, the only way local governments have been able to do that within a world where they're not making the same money from land-related taxes or land revenue, is that they have to cut back elsewhere. And so they've been racking up arrears. They haven't been paying their suppliers and contractors. State employees across the country have been subject to pay cuts. You know, local authorities have gone after back taxes, both real and imagined. I mean, it is real austerity. And that has been the consequence and it's something that I didn't have the imagination to foresee and yet that's what we ended up with. We didn't get a crisis, but we got austerity and that's one of the things that's dragging on domestic demand.
Yap Chuin Wei:	Well, in a way, you did talk about how China's banking system, you know, in the book and, you know, in more recent conversations. It's not really built for the private sector. I mean, it's built for SOEs. You address that in the book, in detail. Do you still believe that to be the case? Number one and then... And then in the book, you also talked about... I can't remember whether it was, Xi and Hubei, where Dongfeng is or was it Tianling? Where the Chinese... system does not like the idea of bankrupting companies, of, you know, companies going bankrupt and they would rather fold them into another company and just... And just tough it out. And is that something that... that still persists today? One of these, these incredible quotes that you had from the book was, Beijing has unleashed a perpetual debt machine over which it has lost control. Well, that, you know, you've, as you've explained, might have changed, but... But those two things, is China's banking system still not for the private sector? And secondly. The way it treats... Failing companies.
Dinny McMahon:	Yeah. Oh, geez. Chuin Wei, we could talk about this stuff all night. I mean, we...
Yap Chuin Wei:	Sometimes. Yeah.
Dinny McMahon:	Okay, how, does the banking system... does it still... is it still really about the state sector? You know, I haven't done work on this, but I know other people have to say, look, the banks these days provide far more credit to the private sector than they ever have done before, right? But, you know, I've been doing some work with a private credit fund for the last few years and they say, look, yeah, the banks lend more to the private sector, but it doesn't even scratch the... it doesn't even scratch the surface. The degree to which the private sector requires credit is not being met by the banking system. Sure, the banks lend more, but it is... it falls far short of the needs of the real economy. The second thing to keep in mind is that the way that regulators and government advisors talk about this is that they say, look, the banking sector is... they don't say that it doesn't serve the private sector, but what they do say is that it is not fit to meet the needs of this new... economy as envisioned by Xi Jinping, right? This new economy being something led by innovation and industrial upgrading and productivity because most of those gains are going to come from the private sector. And the banks aren't geared towards lending to firms that are, you know, asset-light, that might not be generating a profit yet. that might have great ideas, but don't have a track record. I mean, ultimately, this is the problem of a financial system everywhere. The banking system is not well, you know, positioned to support these firms, which is why Silicon Valley exists, it's why the NASDAQ exists. you know, you've got all this ecosystem of venture capital to kind of help tech startups in California and elsewhere in the United States. So the U.S. has that alternative financial system outside of the banks to be able to support that side of the economy. And Beijing is desperately trying to build that out at the moment in China. Now, in terms of dealing with zombie companies, you know, do they still get absorbed elsewhere? Yeah, I mean, M&A is part of the, the strategy for Beijing's anti-involution campaign. You know, the NDRC just announced that they're, launching an M&A fund, that's gonna be leveraged, you know, it'll be able to be leveraged up to support a trillion renminbi's worth of deals, is what they said. Now, I originally saw that and I'm like, oh, this is about supporting venture capital, it's about supporting innovative new firms by allowing larger firms to come in and buy them, so that, you know, it's an exit without doing an IPO. But the more I read, the more I realize, actually, no, this is probably just as much to do with dealing with over capacity. It's a way of consolidating industries. So yeah, it is still very much, you know, it's still sort of very much part of that approach. And I think the last thing that's worth talking about is, you sort of mentioned the perpetual debt machine. And it's funny because what I described in the book as a perpetual debt machine, that doesn't exist anymore. And yet, even despite these efforts to rein in debt and have a new, you know, a new driver of economic growth. You look at debt levels in China at the moment and the pace of debt growth every year, the pace at which debt is expanding, is still twice the pace of economic growth or it's at least nominal economic growth. So, nominal economic growth was, what, 3.5 or 3.8% last year? debt... the amount of total social financing, so more or less debt, grew at about 8% last year. It's not shadow banking anymore. You know, so much of... it's not households borrowing for mortgages. So much of this debt is state-led. But still, the debt-to-GDP ratio just keeps going up and up and up, in part because that's the only way that they're still managing to maintain these growth... these growth levels.
Yap Chuin Wei:	And when you say state-led, do you mean a corporate state or state-state?
Dinny McMahon:	I... it's mainly state-state, so it is local... it's, you know. Local governments, special purpose bonds, special treasury bonds, you know, policy bank lending to local governments, it's that sort of stuff.
Yap Chuin Wei:	Right, right. I would imagine, you know. You talked about the transfer of bad loans from Tier Link to CDB. I'm pretty sure some of that still exists. I mean, that relationship.
Dinny McMahon:	I'd imagine so, but it's pretty opaque to be able to hunt that down and get a real insight into what's going on these days.

Market Investability and the Search for a New Model

Yap Chuin Wei:	Yeah. You know, I wanted to squeeze in and you talked about, It's, interactions with the U.S. you know, obviously. You know, and you're at Trivium. What do you tell people when you talk about the investability of China these days? and... Sorry, I'd like to double-barrel my questions, which I should. But, What does it say about China's... Collision or... It's contest with the United States and its place. But PPP is the largest economy in the world, in some ways, unavoidable. What does it say about its place in global geopolitics?
Dinny McMahon:	Yeah, the whole question of what do you tell people about whether China's investable? To be honest, other people will tell us whether they think China's investable or not, but certainly, you know, depending on who you are, that narrative has changed. I mean, for investors. For a period of about 3 years, that was the narrative. China's uninvestable. And that's... as soon as asset prices start going up, oh, China's not uninvestable anymore. You know, it's amazing when there's money to be made, how quickly people will change their tune. Although the stock markets in particular are quite interesting because traditionally, Beijing, when it wanted prices to go up. It will... it kind of had a toolkit of things that it would do to try and get prices to rise. It would start by planning a story in, say, the Economic Observer or something, saying, you know. You know, an anonymous op-ed or something saying, hey, shares are undervalued and people would sort of see the signal and go, oh, support's coming and it may or may not result in prices going up. Valuations going up and then, you know, they'd mobilize the national team to buy stocks, they'd make it harder to short sell, they'd have a moratorium on IPOs so that they didn't dilute the amount of money going to stocks. There was just, you know, a tick, tick, tick and tick. There was a list of things they would do. And I think the last time they tried it was the second half of 2023 and it just didn't work anymore. It just... none of it worked. The market had, you know, wasn't paying attention. And so, since the beginning of 2024, they've been taking a different approach. And what they're trying to do is lay the foundations for a more sustainable... what they want is what they call a slow bull market, right?. They want what developed markets have, where the market just, over time, you know, if you zoom out, the market just curves up and to the right, which is not what China has. You know, China has... It goes flat for a decade, it peaks Has a bubble, bubble bursts and then it moves sideways again for a decade and then rinse and repeat. And so they want a slow bull market. They want what the United States has. And so they, they're doing four things. The first thing is they're trying to build public trust in the market and which, I mean, the Chinese public does not trust the stock market. I mean, there's a general perception that the only way to make market in the system is if you have an inside track. Insiders are the only ones who make market, make money. And so, there's been this full-court press for the last two years of just trying to do everything to rebuild trust. You know, go after rule breakers more aggressively, increase the penalties for fraud and increase the penalties for poor audits, you know, reducing the fees that securities firms and mutual funds, you know, charge. Even something from, like, ripping out the servers that, you know, algorithmic traders and high-frequency traders had in the stock markets to kind of show, look, these people aren't going to have an advantage anymore, they're just like you and me. So, a million and one different sort of measures to try and level the playing field And rebuild public trust in the markets. The second thing they're trying to do is, ensure that people who invest get a return, even if the market's not going up. And so they've been pushing listed companies to issue at least one dividend and ideally two each year. The PBOC has been... has a special facility to fund share buybacks. So, you know, there's that. The third thing they're trying to do is inject a degree of, you know, have what they call patient capital playing a greater role. So, some branch of government did some research and they found that, you know, when the bubble bursts in China, you know, the lows are lower and they stay lower for longer than in developed markets. And the reason is because retail investors play a disproportionate role in China's stock markets. And so what they need is pension funds, insurers and just long-term sovereign wealth funds playing a greater role to kind of stabilize the market. And the fourth thing they're trying to do is just really have exciting IPOs. Hard tech IPOs that people can kind of get excited about. So that's the vision. So this kind of comes back to, what do you tell people about whether China is investable? I don't know, but they're trying something radically different from the way that they've managed the markets in the past, that they want something that... they want a market where... which... they want a slow bull market because, you know. they want a new engine for middle-class growth to replace the property sector. They have a rapidly aging population and so they need a way for people to top up their retirement savings. They need a mechanism to fund innovative firms and something that we don't talk about that often, but it's a way to kind of support renminbi internationalization because it creates a renminbi The documentary asset. Yeah. That the rest of the world wants to invest in. So there's a lot of reasons for doing this. Whether it'll work or not, told me that's way above my pay grade, but it speaks to the investability argument. They're trying something different and something that's a lot more appealing to the rest of the world.
Yap Chuin Wei:	Yeah. You know, in a way, as we bump up against time, everything that you just said, in a way, sort of very nicely loops back to Bobby. The lavender-stuffed teddy bears because that was about consumer safety, right? That was about the Chinese consumers desire, I mean, to put it in an understated way, to know that something is safe. And secure for them, which is everything that you just talked about. People want their assurance from China. So, you know, I don't know if you have any last words to add as we head into the close of the hour. Did you, you know, any sort of final comment or...
Dinny McMahon:	Yeah, I mean, just circling back to the book again. I hadn't fully appreciated at the time that I was writing a bookend to a particular era in China's economic history. But at the same time, so much of what's in there as well. is kind of, like, foundational for understanding what's going on as well. It's not like that there was a hard break and all of a sudden we're doing something radically different. But yeah, when I was sitting there, kind of looking at the end of the Chinese Miracle, I think there was an awareness that something had to replace it. But back then, it wasn't immediately obvious what it would be. I mean, we had this narrative that one day China would pivot to being a consumption-led economy. It has unambiguously rejected that road and instead, we have this experiment... which requires the rest of the world to buy Chinese industrial goods in ever-increasing volumes. And the question is, does that break at some point? And does it break at a point prior to China having been able to extract what it needs out of there and perhaps sort of have you know. Restructured domestically in a way that it can generate domestic demand to a degree that it doesn't need the rest of the world as much as it used to. That's kind of the question, I think, at the moment because that's ultimately what it needs to do, but it's not clear whether it's going to be able to pull it off.
Yap Chuin Wei:	Yeah. Well, I smell a sequel. I do, so.
Dinny McMahon:	Don't let my wife hear you say that.
Yap Chuin Wei:	Well, give my regards today and I will. And thank you so much for being with us today, Dinny. It's been such a pleasure. this feels like this chat should have been a long time coming, but thank you so much. It's been a, you know, a great pleasure just walking back through history with you and the current.
Dinny McMahon:	No, likewise, Chuin Wei. It's just great to be able to talk to you about this stuff. As you said, it would have, yeah, long time coming.
Yap Chuin Wei:	Yeah. Well, thank you, Dinny. And thank you, everyone. This is the, Dinny McMahon, Trivium and a former Wall Street Journal colleague, thanks for joining us this morning.