Richard Koo on China's Risk of 'Japanification'

Tracy Alloway (0:10)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

Joe Weisenthal (0:14)

And I'm Joe Weisenthal.

Tracy Alloway (0:16)

Joe, do you remember at the beginning of the year, there was so much excitement about China reopening?

Joe Weisenthal (0:23)

Yes, absolutely. You know, it's interesting, because I think if you go back to last fall, there was all this talk, it's like, why isn't China giving up on COVID-0? When is China gonna give up on COVID-0?

And then, and they're like, oh, it's not gonna happen anytime soon. And then one day it just happened. And everyone's like, okay, here comes China, here comes all the demand from China, it's on.

Tracy Alloway (0:43)

That's right. And so a big plank or portion of the bull thesis for 2023 was that because China was reopening its economy after basically being shut for three years, you were going to get all this additional economic activity. And while we have seen markets rally, it is not, it is definitely not because of China. In fact, China really seems to be struggling here so we have, you know, Chinese manufacturing is still at or near contraction. I think exports are flagging.

Inflation is basically around zero, which might sound great to a number of other countries right now, but of course it means that in China, growth is subpar.

Joe Weisenthal (1:25)

Yeah, I mean, I think it also, the big story for the world too has been oil demand and there was a lot of expectation that's like, okay, commodity prices are kind of soft, but China is going to reopen, oil demand is going to surge. And that was expected to contribute to like further inflationary pressures throughout the world, oil, copper, et cetera. And so yeah, that totally caught that market by surprise and changed a lot of the sort of macro dynamics globally that people were expecting.

Tracy Alloway (1:55)

Yep, so now is the perfect time to dig into what is going on with the Chinese economy. And you know, to some degree, the weakness this year sort of highlights these longer term concerns around China. How is it actually transitioning or developing its economy? Is it going to be able to achieve the ultra high levels of growth that we've seen in the past? Or is it going to fall into something like a middle income trap? What's going on with Chinese local government debt? That's been in the headlines quite a bit recently.

And all of that put together has given rise to this idea of Japanification risk for China. So the notion that you might have ultra high levels of debt that weigh on future growth because everyone has to spend their money basically paying down their debt rather than investing in new and exciting things.

Joe Weisenthal (2:46)

Yeah, it's weird because I feel like there's like, now there's two conflicting themes that I think about with China. So one is exactly as you said, that there is this sort of sluggish growth, over capacity, debt, indebted cities and so forth, lack of domestic consumption. And then the other one is this sort of awe that the world has at like, the booming electric vehicle exports, that they finally got the first flight of their domestic wide body aviation, that first plan, the COMAC, that we talked about with Brad Setzer.

And of course, all the anxiety about the chip progress that the country has made, which is why the Biden administration has cut off access to various high tech, cutting edge semiconductor equipment. So there's these two things, there's this sort of shock and awe at the success they're having in batteries, cars, and so forth. At the same time, the macro numbers do not look good.

Tracy Alloway (3:39)

It's true. China is always a giant waiting in the wings to take over everyone else's economy and also simultaneously this bundle of vulnerabilities that people are worried is going to tip into a massive financial crisis. That's always the case.

But okay, I have to say, we really do have the perfect guest to discuss all of this. We're going to be speaking with Richard Koo, chief economist at the Nomura Research Institute, which is the research arm of Japan's biggest brokerage Nomura. And of course, he is also the man who basically wrote the book on balance sheet recession. So Richard, thank you so much for coming back on Odd Lots.

Richard Koo (4:18)

Oh, thank you for having me.

Tracy Alloway (4:19)

Yeah, really appreciate it. Maybe just to begin with, I know you've been talking and writing about this theme of a potential balance sheet recession in China. You also have a book that came out, I think it was just last year, called Pursued Economy, where you talk quite a lot about the trajectory of China's economy.