Media Call: Global Fallout of China's Market Volatility

Media Call: The Global Fallout of China's Market Volatility

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Economic Crises

Financial Markets

CFR experts Robert Kahn and Willem H. Buiter join Zhiwu Chen, Yale University professor of finance and Foreign Affairs contributor, to discuss the health of the Chinese economy, where it's heading, and what it means for the global economy. 


Robert Kahn

Steven A. Tananbaum Senior Fellow for International Economics, Council on Foreign Relations

Willem H. Buiter

Adjunct Senior Fellow, Council on Foreign Relations

Zhiwu Chen

Professor of Finance, Yale University


Michael Levi

David M. Rubenstein Senior Fellow for Energy and the Environment and Director of the Maurice R. Greenberg Center for Geoeconomic Studies, Council on Foreign Relations

LEVI: Good morning, and thank you all for joining the call this morning.

My name is Michael Levi. I am a senior fellow here at the Council on Foreign Relations and direct the Maurice R. Greenberg Center for Geoeconomic Studies here. We try to bring together the global economy and international politics to help people understand the world better, and this is a topic that’s perfect for that world.

We’re going to be talking about developments in the Chinese economy and Chinese markets and their global implications. We have three fantastic people with us to help us all understand what’s going on and where we might be heading.

Zhiwu Chen is a professor of finance at Yale University. He is a frequent writer on the Chinese economy and author of a recent Foreign Affairs article: “China’s Dangerous Debt: Why the Chinese Economy Could Be Heading for Trouble.” Recent, but not so recent that it was written—it was actually written before the recent turbulence.

Rob Kahn is the Steven A. Tananbaum Senior Fellow for International Economics here at the Council on Foreign Relations. He has a sterling record in both the public and private sectors, focused on the global economy, and writes regularly on these issues.

And Willem Buiter is global chief economist at Citigroup and an adjunct senior fellow here at the Council on Foreign Relations. He, too, has a wonderful record in academia, in the public sector, and in the private and financial world.

This call is on the record. That means that the speakers’ comments are on the record. Your questions, which we will go to after an opening conversation, are also part of the audio and transcript that gets posted, so just so you know that.

I’m going to moderate a conversation for about 20 minutes among the three guests, and then we’re going to turn things over to questions from the group.

And I want to start by asking each of you essentially the same question. We’ve seen headlines day after day in recent weeks about the Chinese stock market. Does the Chinese—does what’s happening in the Chinese stock market matter? Zhiwu, I’ll go to you first.

CHEN: Thank you, Michael.

Let me highlight three points. First, what has been happening in the Chinese stock market by itself does not really matter so much to the Chinese society or to the world economy, mainly because the stock market there has been a sideshow, not only to the economy but also to the financial system. You know, more than 80 percent of the financial resources are really in the banks in China. So as long as the banking system is OK, whatever happens to the stock market is more or less not as relevant to the Chinese economy.

My second point is, at the same time, I should emphasize that what has been happening in the stock market is a symptom of the structural problems in the underlying economy. As I have been saying to my friends over the last couple of years, the best news out of the Chinese economy was really two years ago. So for the last two years, the government regulators and decision-makers in China have been on the defense, trying to fight off whatever challenge there may be from the financial sector, from the real economy, or from the larger Chinese society. So if you look back, you know, since 2012, every year—you know, in 2013, 2014, and this year again, during the first quarter of each year the real economy would show some growth challenge. And then, during the second quarter, the government would respond either through fiscal policies or monetary policies. And then the third quarter the economy would stabilize, and then the fourth quarter the economy would improve somewhat. And then, the next year, you go through the same cycle. So this year we have seen the same cycle, except the efforts by the government to contain the problems and challenges in the economy have been not as effective as they used to be, so the stock market has taken notice of what—you know, what has been happening in the real economy. So in that sense, I expect, you know, the government in China to still struggle in the next few years before some more challenging economic crisis may actually happen.

My third point is, you know, many market participants around the world may be thinking that a financial crisis is upcoming and not avoidable in China. But I would say a financial crisis of a very major magnitude is really highly, highly unlikely to happen, mainly—as a financial economist, I know, you know, a financial crisis typically requires one key condition: that is, a lot of panic—a lot of, a lot of panic. But given that the banks and other financial institutions are all controlled, or even majority—by far majority owned by the government, financial—a real financial panic is highly unlikely to happen there. So I would say we may see some economic crisis in China in the—in the next few years, but a financial crisis is highly unlikely.

I would say that the Japanese experience over the last two decades should be quite telling because, going back to 1990, Japan had a lot of challenges economically and financially, but they did not really go through a major financial crisis. So over the last two decades they have been more or less recovering from all the bad investments that took place in the 1980s and even early 1990s. I think something like that is likely to happen in the next five to 10 years in China.

So I should stop here.

LEVI: That’s a great start to our discussion.

Willem, I want to turn to you next. Same fundamental question: Does what’s happening in the Chinese stock market matter? But let’s take it a bit further. You have views on how much the Chinese economy has slowed down and what’s driving a slowdown. Talk about that a bit.

BUITER: Yeah, the stock market in China is a second-order phenomenon. I’ll try to keep this brief. China’s problems are excessive leverage in the corporate sector, not just as we—in the local government sector, and the very fragile banking system, and—shadow banking system. As Chen pointed out, it won’t be allowed to collapse because it is underwritten by the government, but it won’t be a source of great funding strength. There is excess capacity and a pathetically low rate of return on capital expenditure, right? Invest 50 percent of GDP and get, even in the official data, 7 percent growth. The true data is probably something closer to 4 ½ percent or less. So it is an economy that, I think, is sliding into recession. And what the stock market reminds us of, I think, especially this sequence of the government first cheerleading the stock market boom and bubble—because quite a few of the—of the local pundits believed that this was a great way of deleveraging without paying for the corporate sector, to have a stock market bubble. And then, of course, the rather panicky and incompetent reaction in response.

So why it matters is that the competence of the Chinese authorities as managers of the macro economy is really in question—the messing around with monetary policy, the hinting on doing things on the fiscal side through the policy banks. But I think the only thing that is likely to stop China from going into, I think, recession—which is, you know, 4 percent growth on the official data, the mendacious official data, for a year or so—is a large consumption-oriented fiscal stimulus, funded through the central government and preferably monetized by the People’s Bank of China.

Well, they’re not ready for that yet. Despite, I think, the economy crying out for it, the Chinese leadership is not ready for this. So I think they will respond, but they will respond too late to avoid a recession, and which is likely to drag the global economy with it down to a global growth rate below 2 percent, which is my definition of a global recession. Not every country needs go into recession. The U.S. might well avoid it. But everybody will be adversely affected.

The stock market, I think, itself is a sideshow. Consumption effects, you know, wealth effects, minor. Almost no capex in China is funded through share issue. And so it is a symbol of the policy failure rather than intrinsically economically important.

LEVI: A lot of great stuff to get into there, particularly as we start to look at the international spillovers.

Rob, I want to go quickly to you. What does the recent experience tell you about the ability of the Chinese government to handle its economy properly?

KAHN: Well, I think Willem has it right there in the sense that the sharp market reaction has left not only the fundamentals, as Zhiwu highlighted at the start here, but also a very herky-jerky policy response by the authorities on monetary policy, on fiscal policy, and importantly on regulatory policy. It’s undermined not only the confidence in the authorities to get this right, but also that market pricing is right. If you want people to come into these markets, to come back in, you have to have some confidence in the prices that you’re coming in at, and that’s been lost.

Now, until recently market participants had been incredibly sanguine—both domestic and international investors had been incredibly sanguine. The Chinese economy was growing, and authorities had the resources and the control to easily manage any disruption. Now that’s clearly been punctured. To some extent that’s not entirely a bad thing. I think that was probably excessive confidence. But confidence in these markets will not be easily restored, and I do think that what it does mean is that bad news or missteps by the authorities of the type that we’ve touched on will be seen in much more significant volatility, both in China and globally, going forward. So in that sense, it is, in a sense, evidence of a regime change that does matter.

LEVI: I want to shift to the global economy. But first, very quickly, Zhiwu, I want to go back to you. You wrote this article about the Chinese debt overhang, real estate market, SOEs. Give us a really brief capsule, but then tell us, what does the last two months tell you about the Chinese government’s ability to unwind this, to deal with this problem that’s been building up over recent years?

CHEN: Yeah, the debt buildup, especially at the local government level, is continuing. You know, many of you probably have read that the Ministry of Finance has undertaken a program to swap local government debt into long-term local government bonds. So they have been quite successful, even though they struggled initially to finish this swap, now with a total of something like 3 trillion renminbi of local government debt being swapped into long-term government bonds. But still, you know, just like when we look at how the government has been trying to support the stock prices, as well as trying to prevent a real economic slowdown, at the end of the day they have no other choices but rely on either money printing, or more indirectly through a lot of debt, to, you know, maintain economic growth, as well as to support the stock prices. So all such efforts are simply making the overall debt level in China increasing rather than, you know, going down. So what I wrote in the article is still true, or maybe the problem has become much worse and will get even more worse.

LEVI: All right.

Let’s turn to the global implications of all of this. I’ll start with Willem and then go to Rob with a similar question. Willem, when you look at all of the ways that what’s happening in the real Chinese economy—when you look at all the ways that what’s happening there can spill over to the rest of the world, what are your sort of top one or two channels that you’re looking at for transmitting the problems in China to the rest of the world?

BUITER: Well, the first one, obviously, is commodity prices. China is the largest absorber of hard commodities—oil, coal, steel, and all that—and the kind of hammering of oil prices and other commodity prices that we’ve seen in the last couple of months is no accident. Of course, it’s partly supply driven, but if the major source of global demand growth for commodities is slowing down quite markedly, I think you’re going to have a major, lasting decline in relative commodity prices. So bad news for commodity exporters, which are mainly EMs; good news for most commodity importers—good news for India, good news for Japan, good news for Western Europe. The U.S., slightly mixed picture because there is quite a bit of capex in oil-related sectors that is at risk. So that’s one transmission channel.

The other one is, of course, the trade channel. I mean, China is, depending on how you measure it, between 20 and 25 percent of global GDP. It’s the size of the—of the U.S. And its slowdown will affect all of us. The U.S. is less directly exposed to China than Europe or, indeed, Japan, but one has to add in indirect exposures through the countries and regions to which the U.S. exports directly. And there’s no doubt that the external environment for all of us—all countries in the world—has become worse as a result of what now looks like an imminent recession in China.

And finally, there’s the financial transmission channel. The lack of confidence—I think Rob Kahn mentioned—is that people don’t trust prices in the Chinese markets anymore. I think people are rethinking what are, you know, fair stock prices everywhere in the world if there’s going to be a continuation of the global slowdown that we have seen for the last couple of years, and I think that there will be. No country is surprising on the upside, except for the U.S. today. (Laughs.) And while a lot of EMs and advanced economies—Japan, India, and now China—are surprising in a significant way on the downside.

So trade, commodity prices, and then financial nervousness and the need to re-price south.

LEVI: Rob, what are your top one or two? I know you’ve talked in particular about currency moves.

KAHN: Yeah, and of course, I’ve been looking at it a lot from the U.S. perspective. And, as has been touched on, the direct trade links to the U.S. from China is rather actually quite modest. The secondary effects with other trading partners add up, but if you really want to get a big, direct growth effect on the U.S. it has to come through the financial conditions.

Now, that can happen through declines in asset prices more broadly, but the one I think you really have to watch is the exchange rate channel. And that is not just because the possibility of a further significant renminbi depreciation in coming weeks or months, which is quite possible. If it was just that, the trade-weighted dollar—which U.S. policymakers, including the Fed, look at most closely—wouldn’t move that much, given the relatively small direct weight of China in our trade. But if others follow as a matter of policy or as a market reaction, then cumulatively the effects can be quite significant. And of course, that comes after a period where dollar appreciation has taken a pretty significant chunk off U.S. growth already. And so I do think that that presents both economic and political vulnerabilities for the U.S.

Certainly, it’s a bit—you know, if you look at the large models that I’ve looked at, it’s mainly through these sort of financial conditions channels and the exchange rate is where the biggest effects on the U.S. could come.

LEVI: What about other economies in the region? We’ve talked about the sort of broad effect on the global economy. We’ve talked about commodities exports. What about—what about other economies in the region? This is for any of you who’d like to jump on this.

CHEN: Michael, can I add a positive to the picture?

LEVI: Please.

CHEN: Because, as we know, when there—when there are problems coming up, the Chinese government will increase liquidity through money printing and so on. And then, at the same time, investment opportunities are very limited; there are not as many, you know, good investment opportunities there in China. So as a result of the increase in liquidity supply in China, more capital will flow out of China, and the U.S. will be among the first economies to really benefit.

I have been away from Yale on—have been on leave from Yale for a year, and then now I’m back here. And then, talking to people in New York, then, I’ve been so impressed by how many new deals—new purchases of real estate and businesses that have happened over the last one year in New York and outside New York. So I think this trend will get even more clear, more sort of stronger if there are more challenges and more turbulences within the Chinese stock market and the real estate market and the economy there. So I think capital outflow will speed up as a result of the troubles there in China.

BUITER: Could I follow up on this, also, for a second?

LEVI: Please.

BUITER: To be clear, that one of the ways that the Chinese authorities will try to regain some demand is through the external channel. We anticipate, you know, 6.80 renminbi to the dollar by the end of the year, another sort of 4-ish percent devaluation of the benchmark or the fix. But China itself will get relatively little effect of the depreciation out of that because most of its neighbors—you know, the Taiwans, the Philippines of this world—basically, every country except Hong Kong, which is tied to the U.S. dollar—(laughs)—will depreciate with the renminbi. And in the rest of the world, I think the policy response, which seems to be restricted by and large to further monetary easing, will also be one of following the renminbi down. And there will be just one exception—and as Rob Kahn suggested, that’s going to be the U.S. dollar, which is likely—especially if the Fed, driven by, you know, its views on the strengths of the U.S. recovery, decides to raise rates this September or this year, the dollar could go through the roof and do considerable damage directly through its effect on the stock market valuations of externally exposed U.S. enterprises listed here, but also ultimately through the trade channels, so exports and imports. So I think the U.S. will be the major victim, if you will, of the likely exchange rate responses to the Chinese slowdown. Europe, not. Other EMs, no—except those that are tied to the U.S. dollar, like the Gulf States and Hong Kong.

KAHN: Michael?

LEVI: It would be possible to get a double whammy out of commodities prices and the exchange rate impact.

Rob, you wanted a quick point, and then I want to—a warning to—a warning to everyone. After Rob speaks, I’m going to go to questions, so prepare your questions.

KAHN: Just two points to add to that.

One is on the country distribution. You know, I do think we’re all very much focused on Asia because you have countries like Malaysia, Indonesia, Korea, Japan, obviously, very much tied to China across a broad range of trade and financial services, and clearly are hit. And you know, we’re very much thinking, as Willem suggested, what’s the policy space to respond? Indonesia this morning announced a fiscal surplus plan. You know, you’re going to have more confidence with countries that can do more than just simply depreciate.

But you also have a set of emerging market commodity exporters, which we’ve touched on, and it includes, importantly, Latin America. And I think sometimes we don’t pay enough attention to the vulnerabilities in countries like Brazil, because there’s underlying problems to which this is exacerbating. But there’s also countries like Chile, for example, which have pretty strong and close ties through the commodity channel. And so I think maybe in some ways that may be the story going forward in terms of the kind of effects in the broader—in broader regions.

But let me also follow on—

BUITER: Protectionism is another issue, right, that could be an issue.

KAHN: I’m sorry?

BUITER: Protectionism—

KAHN: Absolutely. I mean, in some ways, in the last few years I have felt that capital controls and protectionism has been the dog that hasn’t barked so much, and whether—what is—very much is a possible reaction here.

And let me bring that back to the U.S., because this point about the reaction in the U.S. if you have a broad, global effort to depreciate against the dollar as the primary policy response to this shock, and then later on reinforced, perhaps, by additional QE in Japan or additional measures in Europe—so the sense in which everybody is trying to get out of this on the back of the U.S. That is not only potentially very significant economically, it’s also going to be extremely difficult for the administration to handle politically. They already have a TPP negotiation which is in difficult shape. There is strong protectionist, you know, talk on the Hill. You may have already seen the last week, in the—in the wake of these moves, some pretty strong statements from some of the Republican presidential candidates, like Donald Trump and Scott Walker, not just on China directly but whether there should be a state visit next month and the like. I do think that this could become very noisy and very hot very quickly.

Now, how that plays out I’m not sure. There is a certain irony to all this, that in the last several months the focus of this protectionist pressure was very much in terms of currency manipulation clauses in Trade Promotion Authority. Those draft pieces of legislation, which have not been adopted so far, would have not tarred China, ironically; China’s not a manipulator, as defined under that. But it does, I think, mean that what I would call the substantial and real issues that are confronting the U.S.-China relationship right now on the economic front—things like cyber, things like property rights, and government procurement—are going to become much more difficult to deal with and are going to bring forward calls for a lot more protectionism in the months ahead. Now, whether that, in the context of fiscal cliffs and, you know, showdowns over must-pass legislation, the debt limit, and all the other things that are likely to happen in the fall ends up catching a ride, I think there’s actually some risk to that which has been underestimated by the markets.

LEVI: All right. So we’ve all—we’ve all had—


LEVI: I want—I’d like to go to questions. And just—I want to—I was going to say, we all had a burning question, which is, is it possible to have any conversation right now without mentioning Donald Trump? The answer is clearly no. (Laughter.) There is no—there is no safe haven.

Let’s go to questions. Operator, can you give instructions? I want to remind questioners before they start in, also, that this call is on the record.

OPERATOR: Thank you. At this time, we will open the floor for questions. (Gives queuing instructions.)

Our first question comes from Andrew Mayeda with Bloomberg.

Q: Hi. Thanks for taking my questions. We learned today that the Chinese have been telling treasuries to try to prop up the RMB. And I’m wondering if any of you see any significance in that. I mean, a lot of people for a long time have kind of talked about this Faustian bargain between China and the U.S., and predicting that eventually the way that it would unwind would be that China would start to sell treasuries. Is this the beginning of that? Is this just a one-off thing? What are your thoughts on that? Thank you.

LEVI: It looks like we have multiple people on this call with views on this. Why don’t we start with Willem?

BUITER: Well, clearly if the Chinese authorities believe that there is excessive downward pressure on the renminbi, they will sell reserves. And reserves are mainly U.S. treasuries, so it’s—or, more generally, U.S. dollars and overseas assets. That’s the bulk of global reserves anywhere, and it’s the bulk of Chinese reserves. So in some sense, given the fact that they are trying to prevent a disorderly rout and a premature, further forced lowering of the—of the benchmark, they have no—they have no choice. I don’t think this is a significant measure.

This is no threat. This is what reserves they have. And this is what they will do and continue to do whenever they feel that the exchange rate gets ahead of itself. I do think it will further weaken the exchange rate, but I also think that they will try and manage it. Chinese leadership does not believe, as is apparent now, in freely floating assets markets—be it stock markets or exchange markets—so they will intervene. When they want to weaken it, the renminbi, they will—they will buy U.S. dollars. And then when they want to strengthen it, they will sell it. That’s what countries do. There’s no other significance to it.

CHEN: Yeah, I believe that this will happen on a continuous basis, because the Central Bank of China will want to manage a gradual devaluation of the renminbi. They’re not going to do this kind of one-off devaluation measures anymore—at least not often. Of course, you know, two weeks ago they had this one-off big devaluation, partly because of this upcoming state visit by President Xi Jinping to the United States. So they were left—they were given a very small window of time to achieve some devaluation without affecting the sentimental aspects here for this big upcoming state visit.

But going into the future—because they want to manage a gradual devaluation, so they will need to sell off U.S. treasuries, because the U.S. treasuries have the highest liquidity—offer the highest liquidity. And this is one obvious area where they want to get the U.S. dollars to buy renminbi. So this gradual devaluation policy preference will mean a continuous process of gradually unwinding some U.S. treasuries.

LEVI: Rob, Willem talked about sort of economic and technical reasons for this, and Zhiwu talked about the economic reasons but also a desire on the part of Chinese policymakers to essentially not upset U.S. policymakers. You talked about the politics of it earlier. Are the Chinese policymakers succeeding in doing what they’re trying to do for their own economy without upsetting U.S. policymakers?

KAHN: Well, I think so far. But the U.S. administration’s under a lot of pressure on this. You know, they have—as I said, they have been selling treasuries for a while to try to, you know, offset capital output pressures on the currency and manage this process. I think what you saw a couple of weeks ago when they moved to a more market-determined exchange rate—something the U.S., by the way, had been calling for for some time. Of course, it generated the start of this devaluation cycle. And that put the administration in a very tough spot. They wanted to support the market reforms, but they want to sell a clear signal not just to China but to other countries in the region, this is not a free get out of jail card to simply depreciate. So in that sense, so far the administration’s kind of held fire. They’ve acknowledged that there are legitimate, underlying pressures that need to be released. But I do think we’re at a point where if these trends were to continue, the—you know, you might find that it becomes a problem for the bilateral relationship.

LEVI: All right. Operator, do we have another question on the line?

OPERATOR: Yes, sir. Our next question comes from Jim Dzjeman (ph) with Pacifica Radio.

Q: Hi, can you hear me?

LEVI: Yes, we can.

Q: Yes. Thank you, gentlemen, for your comments. I have two questions. First of all, how do you see the domestic politics that we’re engaged in this presidential race which, on the one hand, in one party is conjuring up all sorts of nativist imagery—we referred earlier to Donald Trump, you could certainly go to the comments of other presidential candidates in the GOP. And juxtaposed with that, is something of a phenomenon where you have outright, self-declared social democrat leading against the democratic contender. And I’m curious how you see these kind of domestic American political, out of the people comments and opinions interacting with this issue of the question of China.

And secondly, I’d like you to give your comments about how this has affected Africa. How does the recessionary trends in China impact on Africa?

LEVI: So let’s take the first one. You know, typically the international economy is not a major factor, at least explicitly, in U.S. presidential politics. Does what’s happening in China, does what might happen in China over the next year have the potential to change that in this year’s cycle? Rob, do you have a view on that?

KAHN: Well, I think we see—I agree with you that ultimately politics are local and domestic and the international factors tend to recede as we get closer to the election. We certainly have these flashpoints that have arisen on the international side. We have now the issue of what we do about Ex-Im. This is still pending out there, and I think ties very much into this. Currency manipulation language, as I said earlier, I think could reemerge. I do think it is easy—has been easy to see China as a scapegoat for our economic problems—be they issues of wages and inequality, for example. And I think that that’s something both sides have found, you know, they could hook onto.

So, you know, yeah, I think we’re very close to the point where it could become quite a negative factor. Now, how does it lead to actual changes in policies is more than negative. It’s more the—with creating an environment where TPP cannot be concluded, where TTIP can’t—the trade agreement with Europe can’t go forward, where the administration gets pressured to take much more aggressive stance on trade. Obviously, those are risk factors. You know, we haven’t—if I can step back and just make the broader point. You know, from World War II till about 2007, global trade growth outpaced world growth. And that was something that was very supportive to our politics, but also supportive to the U.S. economy. And since 2007, you’ve had trade growing less rapidly and activity. And I think we’re definitely in an environment now where we’re seeing a shift towards a more protectionist-style debate. So I think the questioner’s right to say we’re seeing this on both sides, although it’s framed very differently. And, if anything, I think that that is going to get worse.

LEVI: Willem, talk about Africa a little bit. There’s obviously the commodity price channel. What else should people be thinking about?

BUITER: Well, clearly, like most other parts of the world, but especially commodity-exporting sections of the world, Africa will be hit by the continued declining commodity prices, and by weakening demand for its exports. Remember, Africa is beginning to be a much more diversified exporter of goods and services than the old-style commodity exporters that many still have in mind. That said, there’s likely to be a beneficiary from the Chinese saving glut, in the sense that a lot of Chinese foreign investment, including FDI, is likely to be headed that way, as domestic capital expenditure in China weakens and their continuing savings surpluses have to be invested abroad. So I think there may be some benefit through the capital account and infrastructure investment that could be funded out of that. But on balance, again, on a country-by-country basis, looking at the commodity-exporting countries primarily, they will suffer, along with the rest of us, yeah.

LEVI: Zhiwu, can you pick up on the capital outflows question?

Q: I was just going to ask about—don’t you see a political backlash (to the ?) investments?

LEVI: Zhiwu, can you—can you—

CHEN: Yeah. So, yeah, Africa will overall benefit. I think especially, you know, when devaluation and other things happen. The geopolitical tensions will rise between the U.S. and China and other developed countries and China as well. And that will just make China want to go to Africa and then South America more in terms of places to make new investments and so on. So on that front, Africa and South America will benefit to some extent, although I agree with Willem that these are regions where China used to, or still continues to, import a lot of commodities and natural resources, including oil from. So they—on those fronts, yes, they will suffer.

LEVI: I’m curious, to any of you here, because Willem and Zhiwu both pointed toward capital outflows. In the last big commodities price crash that we had, you saw big Chinese investments in commodity-producing opportunities around the world. You don’t seem to have seen that same phenomenon over the last year. Is it still going to show up later, or are we in a different set of circumstances and we shouldn’t be looking for that?

BUITER: Well, I think they will address the problem, but not necessarily in commodities, the way they did before, right? I think China will try to acquire a more balanced external portfolio of FDI assets, to include—I think to include natural resources, it will include manufacturing, stakes in high-tech industries where domestic politics permit these to be sold, I think. And, of course, I think globally, you know, some version of the one road, one belt, you know, infrastructure projects will be domestically funded. So I can see the whole range of projects, not necessarily commodity-related, that China is going to invest in, which itself will, of course, create a political backlash.

I mean, domestic U.S. politics, while it is primarily, as Rob pointed out, about local issues, protectionism always plays well. And protectionism of the right, you know, the nativist, anti-immigrant rhetoric of a Trump, or protectionism of the left, you know, the traditional—the democratic socialists are—you know, they have protectionism instincts because they want to protect the workers against foreign competition. So there’s an alliance, if you want, across the left and right spectrum in making trade-restrictive noises. I don’t think it’s going to be dominant, but it will be, I think, an issue, especially in some of the states that are most directly exposed to competition from China and other countries whose currency is going to depreciated vis-à-vis the U.S. dollar.

Q: Yeah, on—

LEVI: Yeah, Operator, can we have any—I want to make sure that people who are waiting get to ask questions. Operator, do we have anyone waiting in the queue?

OPERATOR: Yes, sir. Our next question comes from Preeti Darwha (ph) with Net Asia (sp).

LEVI: Please go ahead.

Q: Hi. My question is, it was mentioned earlier that India stands to benefit from what’s happening in China right now. Could you elaborate on that a little bit?

LEVI: Willem?

BUITER: I said that. It’s very simple. India is the biggest beneficiary from declining oil and gas prices and for not all other, but for many other commodity prices, because it exports more relative to GDP than any other large country. Among the advanced economies, Japan is the major beneficiary of the commodity price decline. And of course, India does not suffer as much as the rest of the world through the trade channels. India also is not a beneficiary of Chinese FDI to any significant scale. So they’re not going to lose out on that. So I think India will on balance be a beneficiary. They have, of course, already responded in a protectionist way to the Chinese—to the renminbi devaluation. But that’s not inconsistent with being a beneficiary—

LEVI: Willem, when you say that they’ve responded in a protectionist way, what in particular are you referring to?

BUITER: Well, they’ve had some minor measure with increased import tariffs on Chinese exports right after the first two—well, the only two, so far—2 percentage cuts in the fix. There was a minor protectionist action. It was signaled in the—in the papers at the time as a potential harbinger of more to come. And I expect more of that, especially for countries that export with China in the—in the manufacturing sector.

LEVI: Operator, do we have another question in the queue?

OPERATOR: Yes, sir. Our next question comes from Johan Welbe Leiben (sp).

Q: Thanks for your comments. The Argentine and Mexican economies are similar in some regards and very different in others on trade, very divergent as far as their intensity. But Mexico’s recently gone through a bunch of economic reforms that the government now needs to show are effective. And aren’t—most people believe, all three of the candidates in Argentina would do major reforms when they take office at the end of the year. Both are also pretty interesting to oil and gas majors. Given the factors that you described, how would Mexico and Argentina be affected, including the—

LEVI: Rob, you raised the Latin America issue. Rob?

KAHN: I think with both those countries, the fiscal space to respond is going to be quite limited. And while, you know, obviously there may be the hope that you would get a better trade—you might get a better trade response to these shots than you would have in the past, because of the reforms that have been put in place in Mexico in particular. I mean, I think it certainly puts more pressure on monetary policy. I would be particular concerned about Argentina in that case because of the lack of capacity to respond and limited—and already limited financial access because of the ongoing disputes with creditors. So I do think the risks across Latin America are probably underestimated.

LEVI: Willem or Zhiwu, do either of you have views on this?

BUITER: Yeah, I think—certainly I think Mexico benefits more from the strength in the U.S. economy as a—as a result of the increased demand for its manufacturing products and services this generates than it suffers from a decline in the oil price. Yes, they have liberated the—liberalized, well—(laughs)—their oil and gas sector, and are expecting FDI in it, which will be discouraged by current low oil prices. But because of 70 years of, you know, autarky in the oil sector, it’s actually, you know, quite a small sector. So the losses that it suffers are a result of the decline in the oil price is, I think, outweighed by the benefits on manufacturing trade. And other liberalizations they’ve done in the field of media, power and all that, and tackling domestic monopolies, will be beneficial, no matter what happens to oil prices.

Argentina first has to see who wins the next election, right? If the elections provide political continuity, then it really doesn’t—(laughs)—doesn’t matter what the oil price is, because there would be a continuation of the dysfunctional economic policies. So, but Mexico, I think has a chance of breaking out of 40 years of underperformance. Whether they will manage it, is another issue. But I think the oil price will actually be a relatively small issue. It’s the liberalization of the rest of their economy that is much more important.

LEVI: Zhiwu, do you have any views on this?

CHEN: Yeah. I thought, you know, the lower—much lower oil price and other transportation costs would make goods from China and Korea and Japan more attractive. So that may be a negative to Mexico, because, you know, the lowered costs for everything, transporting from Asia to this part of the world, will put many Mexican manufacturers at a disadvantage.

LEVI: I would just add that with Mexico, when you look at the real economy I think everything Willem said makes good sense. If you look at government budgets, oil plays a much larger role. Before the price collapsed, it was about a third of government revenues. Now it’s substantially less. It’s hedged a year out, but if you start to look at this over the long term, it creates substantial challenges for the Mexican government and for Mexican politics.

Operator, do we have anyone else in the queue?

OPERATOR: Yes, sir. Our next question comes from David Sands with The Washington Times.

Q: Yeah, hi. Thanks for doing this. A couple of things, semi-related questions: are we possibly looking at China as a replay of Japan, and the lost decade? And one of you mentioned that the Chinese are just not ready for a domestic consumption cut, which seems to be the classic—you know, the right response to this. What’s the political downside of giving your people a bunch of money and telling them to go buy stuff?

CHEN: Can I take this?

LEVI: Please.

CHEN: Yeah, actually, you know, the Chinese government has been saying for more than 20 years that there had to be a shift from investment-driven to consumption-driven in terms of where the Chinese economy gets most of the growth boost. After having said this for 20 years, not much progress has taken place. I have written in several articles to make the point that the Chinese economic growth model, being so investment-driven, is fundamentally determined by the political economic system in China in which the state-owned assets dominate and state-owned enterprises are also a mainstay of the Chinese economy. So when assets and businesses are majority controlled and owned by the government, much of the national income goes to the government, but not to the households, which makes private consumption very difficult to grow.

So this is why, unless privatization really takes place of assets and state-owned businesses, it’s very, very difficult to make private consumption play a bigger role in the Chinese economy. This is why even if the Chinese government is able to manage a lost decade with a very, very low growth or no growth, but without a major economic crisis, to me that would represent a great achievement by the policymakers in China. I realize that Willem and Rob earlier said that what the Chinese officials did in regards with the stock market prices and the devaluation of the renminbi shows not much competence on their part, in terms of their managing the economy and so on. But I would say, you know, given all the political constraints, and given the fact that the reformers and policymakers cannot change the nature of the political economic system of China, there is only that much they can do on the technical side, yeah.

KAHN: I would say there is also—

LEVI: And this is an essential drawing us back to the political context, what’s happening in the economy. I know there’s one more person waiting to ask a question. And we want to end on time. So I want to make sure they get that very quick question in. Operator.

OPERATOR: Thank you. Our next question comes from Rong Shi with Voice of America.

Q: Hi. Can you hear me? Thank you for having this. I have a question on recently the Financial Times reporting on the Premier Li Keqiang will—have very high pressure to responsible for the recent problem that happened in the financial and economic area. I would like to—Professor Chen to comment on that.

LEVI: Yeah, one-minute answer. Lightning round here.

CHEN: Oh, yes. That’s actually—that article is very interesting. I would say it’s right on target. So the premier is in a major difficult position although, I have to say, it’s highly unlikely that he would be replaced before the 19th Party Congress. So he will be able to stay on for at least as long as, you know, the remaining two years and a half, or so. But it is clear to everyone in China that the stock market troubles and so on do not make the premier happy.

LEVI: And we could go on—we could go on for another hour with substance, but we have to end this call. I want to point you—everyone on the call to some more resources if you want to follow up. There’s a lot of coverage on these issues, short term, long term, on, including Professor Chen’s article. collects a lot of the research and writing that people here in the Center for Geoeconomic Studies is doing—are doing. And you can also subscribe to Rob’s global economic monthly, but searching for it on Google and signing up. And I suspect the next monthly issue will have something to say about all of this.

I want to thank Zhiwu, Willem, Rob for all of their insights, for doing this on such notice, and to all of you for joining us this morning. Thank you all and have a good day.

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