When the Politburo met to talk about the economy at the end of July, the general tone was one of contentment.
Despite the disruption of the Trump tariffs, China’s economy has outperformed expectations this year, led by truly remarkable export growth.
In this podcast, Trivium Co-founder Andrew Polk and Dinny McMahon, Head of Markets Research, discuss the state of China’s economy.
The gents get into China’s:
Latest export miracle
Persistently weak household consumption
Efforts to deal with overcapacity
Then they wrap up with some thoughts about what to expect from economic policy for the rest of the year.
Transcript Follows:
Andrew Polk:
Hi, everybody, and welcome to the latest edition of the Trivium China Podcast, a proud member of the Sinica Podcast Network. I'm your host, Trivium Cofounder – Andrew Polk, and I'm joined today by Trivium’s Head of China Markets Research, Dinny McMahon. Dinny, how are you doing, man?
Dinny McMahon:
I’m good, mate. I'm doing fine.
Andrew:
Great. Glad to have you on. We're having Dinny on today, specifically because I want to discuss the state of China's economy, as well as the most recent Politburo meeting, which took place last week. So, just to time stamp this, we're recording on August the 7th, Thursday. The Politburo meeting took place last week on July 30th. And the July Politburo meeting always focuses on the economy, and lays out any economic policy changes that Chinese leaders want to see in the second half of the year.
So, today we're going to discuss first how the Politburo assess the current state of the economy, key areas of economic concern that Chinese leaders are focused on. Then we'll get into our own assessment of strengths and weaknesses in the Chinese economy, with the Q2 economic data having just come out about three weeks ago. We'll look at the ongoing supply demand mismatch in China's economy that a lot of foreign policy makers are focused on, and talk about what that means, both domestically for China and for the world.
And finally, we'll dig into what to watch for going forward in terms of economic policy in the latter half of the year. But before we get into all of that, we have to start with our customary vibe check. Dinny, it's been a minute since you've been on the pod. How's your vibe, man?
Dinny:
My vibe? Well, mate, I made the mistake of booking my son into a summer camp on the other side of the city.
Andrew:
Ooh, that is a mistake. That's a rookie mistake, man. Come on.
Dinny:
I know, yeah, I don't know. So, my vibe is that I've been overstressed dad who's spending way too much time in Chicago traffic.
Andrew:
Yeah. Well, and for those listeners who don't know, Dinny's wife travels a lot, so he's Mister Dad pretty often. You're mister dadding today, or?
Dinny:
I am, and then again next week.
Andrew:
Yeah. So, big mistake. I guess my vibe is a little bit of schadenfreude, just hearing that you've made this big mistake and…
Dinny:
Oh, God, I'm glad I've managed to brighten your day a little bit there.
Andrew:
No, that's a joke. Truly, my vibe is sick. I have done the thing where, or I guess I haven't done the thing, but, pretty regularly, what happens in my household is our seven-year-old gets some kind of illness – virus, whatever it is – from summer camp, friends at school, whatever. That takes a few days. Eventually, our 10-year-old gets whatever the seven-year-old had. Mom's taking care of the girls. Eventually, mom gets the virus, and then, every time, like a week and a half in, I'm like, “Ah, I think I beat it. I think I beat it, I escaped it,” and then whack — basically, 10, 12 days in, I get it. So, I'm in the midst of that now. But enough of that.
A little bit of housekeeping before we get into the meat of the discussion. As usual, a quick reminder that we're not just a podcast here. Trivium China is a strategic advisory firm that helps businesses and investors navigate the China policy landscape, and that includes policy towards China out of Western capitals like D.C., London, Brussels, and others. So, if you need any help maintaining an eye on China policy and policy towards China out of Western capitals, please reach out to us at hq@triviumchina.com.
We'd love to have a conversation about how we can support your business or your fund. Otherwise, if you're interested in receiving more check in content, check out our website. Again, that's www.triviumchina.com, where we have a bunch of different subscriptions, both free and paid. You'll definitely find the China policy intel that you need on our site at varying levels. Like I said, things for investors, to things for businesses, to general China watching subscriptions, and even some free subscriptions. And, finally, please do tell your friends and colleagues about Trivium, specifically the company, so we can help grow our business — and about the podcast, so we can grow our listenership. And with that, let's get into it, Dinny.
Dinny:
Let's do it.
Andrew:
All right. Yeah. As I said, the Politburo held its monthly meeting on July 30th. So, first of all, we're not going to get into this, but the first kind of to do item on the list at the Politburo meeting was that the leadership set a date in October. I actually don't think they announced the exact date, but they said in October, the Party Central Committee will have its 4th plenum, which will officially set the framework for the 15th Five-Year plan, covering 2026 to 2030. So, that's a big deal, and will obviously help to lay out the economic, social, and other governance priorities for the next five years. But we're not really going to talk about that much. Today, we're going to talk about the other items that they discussed, which were specifically charting China's economic policy course for the second half of the year.
Again, I think I mentioned it, but there's three economic-focused Politburo meetings each year. July is one of them. So, it's always highly anticipate that. We watch it closely to see how leaders think about the current state of the economy. The July 1 comes always right after the Q2 economic data is released in mid-July, and then they talk about, you know, any policy adjustments for the rest of the year. So, the TLDR in terms of the Politburo’s economic assessment was that they think overall things are going pretty swimmingly, and they pledge to largely stay the policy course. They did leave the door open for some more economic support, but only really if things take a turn. For example, of course, if things go pear shaped in the U.S.-China trade negotiations. But then they also talked about a few more discrete things that they're keeping an eye on.
First, the Politburo again called for accelerating the issuance and use of government bonds to expedite the flow of fiscal support. So, that's not committing to new fiscal support, but just saying we need to go ahead and get all the money that we committed to spending in the economy at the beginning of the year. Make sure that gets out the door and it's doing so in a timely manner. Then officials called for boosting domestic demand by expanding the consumption of goods, cultivating new growth drivers and services, and improving people's livelihoods. Kind of stuff we've all seen before so no big deviation there.
And then, finally, they pledged to tackle involution style competition, which we've talked about on the pod before, which kind of includes overcapacity. And they're going to do that by cracking down on harmful competition, promoting capacity governance in key industries, and reining in local government incentives that encourage overbuilding. One last thing to note that was absent in the Politburo readout, and notably so, was that there was no mention of the property sector, specifically, at least the property sector. Instead, officials called for “Promoting high quality urban renewal,” which they talked about at a recent urban work conference, kind of outlining their commitment to staying the path on trying to find a new equilibrium for property in the economy.
And so no big push on property in this latest Politburo meeting. But let me stop there. Those are the key things that we kind of took away, or at least highlighted from that meeting. Dinny, what's your sort of top line thinking, key takeaways from this Politburo meeting in July?
Dinny:
Well, for the most part, it was a bit of a non-event. This is the second meeting this year. The Politburo has had to discuss the economy. And before every one of these, there's a little bit of a buzz or kind of anticipation, particularly among markets, of like, won’t they roll out some stimulus? And that was certainly the case back in April, which came hot on the heels of the Liberation Day tariffs.
But I think there was still an element of that this time around as well. It’s like, will they do something to provide additional support to the economy? And they didn't. And I think it's because the powers that be feel pretty confident about the way the economy's performing. Second quarter growth was real GDP growth was 5.2%. Quite frankly, that's awesome. The four-year target’s 5% — that means that they're coming in above it. And so, I think the authority, the Politburo is more than willing just to kind of not only sit back and watch, but kind of sit on its laurels a little bit because the economy is really doing far better than perhaps anyone would have anticipated at this part of the year.
And that in large part, I think, is being driven by exports. The export machine has been going gangbusters, particularly given the tariffs. I don't think anyone was anticipating that export growth would just be as robust as it has been. The July data exports boomed more than 7% year on year. I mean, that's absolutely mind blowing, not just an economy of China’s size, but an economy of China size that is already the world's biggest exporter. To think that it can still post that sort of growth is incredible. So, I think that's really what it comes down to for the Politburo. Yeah, there are still plenty of problems within the Chinese economy. Prices aren't great. There's certainly deflation in the in the industrial sector. Ordinary people, consumer confidence isn't great, but the export sector is going incredibly well.
And that's allowing them to generate growth really robust economic growth, and putting the economy in a really good position.
Andrew:
Yeah. Well, and equally or even more impressive that Chinese exports continue to grow so robustly in the face of significant contractions and shipments to the U.S. because of the tariffs, right? We'll get into the numbers here. But Chinese exporters are quickly finding new markets. Certainly, there's some transshipment there, but much of it's about just rerouting trade. So, a lot of that strength may be exacerbating trade tensions with other economies in the world. So, it may not be doing genuinely geopolitical favors. But economically, it's certainly boosting growth. And then you touched on a couple of things, but we'll get into this as well, is there are certainly pockets of strength and pockets of weaknesses. And I don't even know if you can say pockets, like, you know, the property market still remains in the doldrums.
And I wouldn't say that's an economic pocket. It's a big chunk of economic activity. But just to kind of level set on the latest economic data, we'll get into some of these numbers partly just to see if we think the Politburo is right in its assessment that the economy is doing well, and it'll also help us set the stage for what to expect on economic policy for the rest of the year. So, here's the overview from the recent economic data for Q2, released in mid-July. I'll try not to be too numbers heavy because I know at least when I'm listening to a podcast and people start going down poll results or whatever it is, getting into the numbers, I start to glaze over a little bit, but we want to kind of level set here.
So, as you stated, China's economy grew strongly in the second quarter of the year, with industrial output consumption and exports all beating expectations. Here, I do have to put our normal disclaimer — We are well aware that the Chinese real GDP statistics are not particularly reliable in terms of the outright number. It's a political target. They're going to hit their GDP growth target kind of almost no matter what. But we are not in the business necessarily of trying to estimate alternative estimations of GDP. So, we're going to go up the official numbers for now because we do think they tell us important things at least about the momentum of the economy. So, as Dinny stated, GDP grew 5.2% year over year in Q2. That's down slightly from 5.4% in Q1.
On a seasonally adjusted quarter-on-quarter basis, GDP expanded 1.1% in Q2, down just slightly from 1.2% in Q1. But that's not really a big enough drop to suggest a material slowdown in momentum. The big data point that we think probably shows a better picture of economic momentum is the nominal GDP numbers, which, of course, incorporate price changes across the economy. And that rose just 3.9% in Q2, down from 4.6% in Q1. So, a bigger job from Q1 to Q2 when you look at the nominal data. And that's mostly reflective of ongoing deflationary pressure across the economy. And the reason that that's so important is business profits, wages, government tax receipts are all highly correlated with nominal growth. And that's how people really experience the economy is really through nominal price or nominal economic activity, not through necessarily real economic activity.
And so that might be a better gauge of how companies and consumers are experiencing economic conditions. So, on that score, Q2 was a little bit more disappointing, probably for the average person out there just experiencing the economy. And this, we should also just emphasize, is the ninth consecutive quarter in which nominal GDP has been below real GDP, really reflecting the deeply entrenched deflationary pressures that China's economy is seeing. And that's very much a corollary to the overcapacity and the involution that Chinese officials are increasingly trying to address, and that much of the rest of the world is complaining about. So, we'll get into all that in a bit. But just to dig a little bit further into some numbers, again, not to overwhelm, but just a couple other things I want to touch on is that industrial value added, which is kind of China's general version of industrial output, grew 6.2% year on year in the second quarter, with growth peaking in June, actually at 6.8%, which was the second fastest rate of expansion in 18 months.
So, the industrial side of the economy is really chugging along, and even excelling getting into the end of Q2, which, again, kind of exacerbates the supply-demand mismatch, this overcapacity piece. But it is showing that that part of China's economy and manufacturing and industry is really still humming along. Meanwhile, on the flip side of that, growth in consumer goods sales slowed throughout June. So, you're not seeing the consumer keep demand up to absorb the supply that's coming online from China's economy. Again, a sort of theme we've seen now for many quarters. That said, services sales and services purchases among consumers was actually pretty strong throughout the quarter and into June as well. So, overall, we'd say while consumption is still at relatively low growth rates, it's kind of stabilizing.
So, that is positive for the overall macro picture out of China. And then, finally, foreign demand, as Dinny touched on, continues to provide an off ramp for China's surging industrial production. With the monthly trade surplus reaching USD 114 billion — the highest June surplus on record in that month. I'm going to dig finally into the trade data. We got July trade data just this week. And, as Dinny said, it just shows that the export machine is just absolutely humming. Exports rose last month – 7.2% year on year, up from 5.9% in June. Imports expanded 4% year on year, up from 1.1% in June. And the important part here is that really high-value-added goods are driving exports at the moment. So, semiconductor chip exports surged almost 30% in July.
Auto exports up almost 26% in July. Machinery and electrical product exports up 8%. That's all in the context of exports falling to the U.S. by almost 22% last month. So, just cratering shipments to the U.S. But meanwhile, the rest of the world is picking up the slack. From April to July, shipments to Africa, up 25%, up 10% to ASEAN, up 5% to Latin America, and up 4.5% to the EU. So, Chinese exporters are finding new places to sell their goods. Again, some of that may be a transshipment, but we think a lot of it's really just retooling goods to sell into other markets. Dinny, I threw a lot at you. Let's start with the export print. We've touched on a little bit, but give us more color on how that ties into the Politburo’s latest assessment of economic health.
Dinny:
Yeah. Well, I mean, you look at the contribution of net exports to that GDP print, and it's big. I mean, what? GDP growth is 5.2%, real GDP, and net exports contributed 1.2 percentage points of that. Now, that's down from 2.1 percentage points in the first quarter. That's incredible. I mean that's a huge percentage. But even 1.2 percentage points, that is far in a way of higher than the sort of the normal level, the normal degree to which net exports contribute to Chinese growth. So, this is, I mean, something really special, it’s afoot. But, of course, one of the reasons that sort of exports are growing so aggressively, and it's certainly been the case for the last over a year now, is because of China's deflationary pressures. I mean, the renminbi hasn't really depreciated in a meaningful way, largely because the PBoC is kind of holding the line at 7.2. whenever it ever gets close to that level, the PBoC starts to intervene in one way or the other.
So, the actual currency hasn't depreciated. But if you actually look at the cost or the price of goods that China is exporting, I mean, things have been getting cheaper. So, on one level, we've been saying the volume of stuff being exported overseas is going up, but that's coming at the cost of lower price. And this kind of goes back to the sort of problem, this kind of bifurcation of the Chinese economy. Maybe bifurcation is not the right word, but it's a split in the perception of just how well the Chinese economy is doing. So, if we’re standing outside of China, Chinese economy looks like it's going gangbusters — 5.2% growth. This is incredible. It's exports are growing despite the tariffs. It's globally dominating in key industries like electric vehicles and batteries and solar. And it's the only place in the world which seems to be serious about developing what it calls the low altitude economy, which is just a euphemism for flying cars and better integrating drones into the economy. And then pharmaceutical sector seems to be really going from strength to strength. So, from outside of China, it looks like it is in a position of strength that, in some ways, we would never have anticipated we'd be sort of staring at this point in time. But then, domestically in China, the vibe’s a little bit different.
I mean, people, ordinary Chinese households — Confidence is low, as you pointed out, Andrew. They’re not spending the way they were prior to the pandemic. You look at PBoC and Stats Bureau surveys of consumer confidence — people aren't optimistic about their job prospects. They're not optimistic about their future income growth. And you put all that together, and they kind of look like two very unrelated stories. But in fact, they’re part and parcel of the same thing. Because of industrial overcapacity, because China has managed to ramp up exports, partly because they're cutting prices, that is affecting things like corporate profits.
And, as you pointed out, with deflationary pressures in the industrial sector, falling prices means lower profits, which means that companies are not paying as much tax as they were. It also means they're less able to pay bonuses. A lot of people in various sectors have had to take pay cuts. And, certainly, the outlook of pay rises, even if people have managed to avoid cuts, the outlook for getting any sort of increase is pretty slim. So, it's this really weird position the Chinese economy is in at the moment because growth is unambiguously good, and it is being driven by this robust export sector. But at the same time, this growth is coming at the cost of low prices and hence low profits. And that's having a trickle on effects to really how ordinary people feel about the economy and the ability of the government to generate tax revenue.
Andrew:
Yeah. And you make a good point on the export piece. And I've said this before, I think, which is a lot of people, I think, with the U.S.-China trade war, assumed, well, you know, this would really undercut China's ability to grow its economy because there's a big percentage. I forget if it's like 16%, 17%, 18% of exports go to maybe 14% to the U.S. So, it's a big chunk of exports. But even outside of government policy to offset that, exporters themselves, businesses themselves aren't just going to say, “Well darn it, we lost our biggest customer or one of our biggest customers. I guess it was a good run.” No, they're going to find ways, by hook or crook, to find new customers and to sell in other markets.
And a lot of that comes with reductions of prices. Maybe it's because consumers in these other economies can't afford the same price point as consumers in the U.S. or whatever it is. But you're going to lower your prices you're going to fight for market share, and maintain some level of top line revenue. Now, that, even while you might be maintaining that revenue, maintaining the export sort of market share, it still doesn't feel good. As a business owner myself, I'd rather grow more slowly with a higher profit margin than grow really fast with a really slim profit margin. Right? You reach a point where it's actually better to have lower revenue and have more money going into your pocket. And in fact, at certain levels, if you're actually have negative margins, the more you grow, the more money you're losing.
So, I think a lot of these exporters, they're doing anything they can to survive. But I'm sure, in many ways, it still doesn't feel good. So that's just one little point on the export piece. But then I want to get a little bit more into the domestic piece, which you talked about, and talk in a little bit more depth about the industrial side and the consumer side. So, going over these numbers, again, in different ways just to give more color — So, the industrial value added, grew 6.2%, as I said, throughout Q2, with growth peaking in June. Fastest pace in 18 months. This shows that China's industrial base isn't just growing quickly, but it's also moving up the value chain because growth in high-tech electrical machinery and equipment and semiconductor production, all accelerated in June, with expansion approaching double digit levels in terms of industrial output for those high-tech goods. And then factories are also humming at a pace not seen since the pre-COVID level. So, year to date IVA is up 6.4%. That's the fastest H1 growth since 2018. So, we're now seeing growth rates faster than pre-pandemic levels. And, of course, that is them feeding into overcapacity, which is ballooning across swaths of China's industrial base, leading manufacturers to slash prices as you've talked about.
In fact, the producer price index, which is upstream prices, fell 3.6% in June, the fastest pace of decline since mid-2023. And factory gate prices have now fallen for 33 consecutive months. So, you can see it all there. They are pedal to the metal in terms of just output, but it's absolutely hammering profits and it's absolutely hammering upstream prices. Now, the flip side of that consumption remains stable but not great. So, as I said, retail sales of consumer goods, up 4.8% year on year in June. But that was a sharp drop from May's 6.4% expansion. And more concerning on a seasonally adjusted month-on-month basis, retail sales fell by 0.2%, marking the worst month on month growth rate since late 2022 when the economy was reeling from COVID.
So, we're starting to see a little bit of cracks in some of the consumer goods purchases, which are already low and already sort of on tenterhooks. So, this is going to be an ongoing piece of concern for senior leaders. Of course, they've been talking about getting consumption up more robustly for, I don't know, a couple of years now. And nothing really is making that happen, largely because consumers just aren't feeling super confident. That said, there are some bright spots, so it did show kind of both sides of this. On the consumer goods side, the items that are related to the consumer goods trade-in program are still surging. So, household appliances surged 32.4% year on year in June.
Furniture was up almost 30% also in June. Mobile phones up 14% year on year in June. So, that's showing that this trade-in program is really driving what consumption there is. And on one side, it's positive because you're seeing big jumps in some of these key items, but on the negative side, it's all based on government policy. And we've talked before about how a lot of that's just bringing forward consumption. And if and when that policy sort of runs its course, which we're sort of expecting to happen in September, we could see significant fall off in purchases of goods sort of in the fall. Dinny, what do you make of this strong value added, industrial value added print and strong export print versus consumption?
We've touched on a little bit, but give me more thoughts on your view of that and how it plays into what the Politburo said at the July 30th meeting.
Dinny:
Yeah, well, these days, manufacturing is at the very center of China's new economic model. It's all about innovation and industrial upgrading. And part and parcel of that is exports. Because, given China's stage of development, as China's population becomes richer, they're not going to consume more stuff. I mean, there's a bunch of economists writing about this in China at the moment. It's like China's population already consumes a lot of physical goods, right? The expectation that they might absorb even more is kind of farcical. So, we're kind of at a position at the moment where, on one hand, Beijing's vision of economic growth is all about manufacturing, more advanced manufacturing, more innovative products. But the potential for the Chinese population to absorb that, even a higher the income levels is kind of low.
And so, exports is just central. This sort of strong export growth that we've seen over the last two quarters, well, actually at this point, over the last four quarters, it's not an abnormality. This is kind of the way of the future. This is kind of baked into the new vision of growth. As for consumption, Beijing keeps saying it wants greater, stronger domestic demand led by household spending. But, really, the only way to do that is by giving people more life. Right? So, either you lift confidence and people start spending all the precautionary savings that they racked up during COVID, and you get a consumption bump that way, but that's proving incredibly difficult to do. Nothing that I really do is kind of able to get confidence up again.
Or the other way you do it is you just reallocate wealth. You redistribute the national wealth so people have more money in their pockets, or they are more willing to spend because the things they're saving for, they don't need to save as much for anymore. Like, you increase support for health care or increase the supply of affordable housing or you provide higher pensions or greater support for aged care, or any of that sort of stuff. And, for the most part, Beijing isn't doing that, with one very clear exception. We kind of said this before – Beijing has got a very fundamental aversion to increasing welfare, specifically if they have to do it out of debt. Now, the one exception to that is neonatal pro-fertility policies. We've already seen that over the last couple of weeks. It's that they're willing to spend on free… what was it?
Andrew:
Pre-school.
Dinny:
Pre-school and heavily subsidized childcare. That doesn't come as a surprise at all. That's not then going against this golden rule of like, well, we're not going to borrow to pay welfare. In fact, it's like they've identified the shrinking population as being a national security issue. It's a fact, though, this is no longer a welfare issue. It's a security issue. And hence all of a sudden funds become available for it. So, they're not willing, unlike a large scale, to reallocate wealth in a way that's going to get consumption going. So, instead, they're doing what they've been trying to do for the last few years. It's all about this idea of unlocking latent demand — that people would only spend if I had access to the things I want to spend on.
And that was originally about goods, like trying to get people in rural areas to buy electric vehicles and building e-commerce fulfillment centers in rural areas so people in the countryside would be more willing to buy stuff online. But increasingly that's kind of shifting to the services area as well. Same rationale, a whole lot of latent demand – we just have to unlock it. And so, they talk a lot about the ice and snow economy, which is about getting people to go to ski resorts. And they talk about needing to build a cruise industry. They had the, what was it? The boosting consumption action plan in, what was it? April or May? One of the action points there was developing an RV industry. That's sort of campervans for people outside of the United States.
But it's this idea that, you know, if we build it, they will come. There's all this latent demand. We've got this burgeoning middle class. What does the middle class do in the United States and Europe? Well, they buy an RV and they go driving around the countryside. So, we need to cultivate that sort of industry. I do not doubt to a certain extent that's true. But the issue isn't that people aren't spending because they don't have access to the things they want to spend on. The issue is they don't have the money, and they're not confident to spend what they have. So really, this Beijing plan of unlocking like demand, it's really just the latest incarnation of a pro investment growth strategy. What we do now is we will encourage some aspect of the economy to invest. We've overinvested in property; we've overinvested in infrastructure. Went pretty much on the borderline of having overinvested in manufacturing. Let's get service industries to sort of ramp up investment. We'll say it's all about unlocking latent demand, and that will be the next driver of growth. So, I think that's kind of where we are with consumption at the moment.
They talk a lot about it, but their efforts to boost consumption is not the way that any developed economy would typically go about it, which is about we ensure people have more money and then we let them spend. This is about, “Well, we're not worried about how much money they have. We're just going to give them more stuff they can spend on,” which kind of feels like putting the cart before the horse.
00:30:31
Andrew:
I heard Arthur Kroeber from Dragonomics, Gavekal Dragonomics make a point about this on the Odd Lots Podcast, which I definitely encourage people to go listen to, I don’t know, a couple months ago, saying that Chinese leaders don't think about consumption in the same way as Western policymakers, as you said. And they view their role as basically shepherding and guiding investment and spending in the economy to unlock certain parts of the economy. And so, it's very clear that that's the approach they're taking when it comes to consumption. The government role isn't to boost consumption per se. It's to guide resources in pursuit of certain outcomes. And whether or not that logic is right, you can see it very much being pursued in this case. Arthur said it much more eloquently than I did.
So, again, I encourage people to go listen to that. But Dinny, one other thing, just to quickly plug something that's coming out from Trivium soon, is Dinny's been working on this big yearlong project, year and a half now, looking at what China's economy is likely to look like in 2035. We'll be sending that out to readers in the next few weeks once it's officially published and talking about it a lot on the podcast. And then Dinny's also doing a series of explainer videos on some of the key takeaways from that report. And the first one that he's about to put out is on the idea that China is not trying to rebalance towards consumption. I know you just went over a lot of these points, but Dinny just talk to me about China can support consumption and not be rebalancing towards consumption.
In other words, it can also be pushing higher value-added manufacturing industry both at the same time without consumption becoming necessarily the “driver of growth” or a bigger part of GDP. Is that right? Is that the right way to think about it?
Dinny:
Yeah, absolutely. Look, I think there's been so much talk about consumption, particularly this year, but there were two really discretely different consumption-related issues. And they typically get conflated a lot. There's the whole debate about whether China can rebalance towards consumption, which is what you were getting at that consumption then becomes the driver of the economy. Most of the economic activity is driven by household consumption. And that's a radical change from the way things have been done in the past when it was all about investment mainly in property and infrastructure and whatnot. But the other issue is that consumption has been weak since the pandemic. Sure, people are spending, retail sales are still increasing. There hasn't been a contraction except at sort of the low point of the COVID years.
But coming out the back of COVID, people just haven't been spending the way that they used to. So, you can have pro-consumption policies, you can have efforts to support and boost consumption, which are not oriented towards putting consumption at the heart of the economy. It's as much as anything oriented towards, A, trying to get consumption back to where it was prior to the pandemic. And B, just ensuring that it makes a greater contribution so that China doesn't have to be as dependent on investing in manufacturing or exports as it used to be.
So, that's kind of where we are. So, I mean, the point and I'm making in the first video is that there is no rebalancing going on for various reasons. But what Beijing is trying to do is get people spending the way that they used to, although their approach is like, I was just saying a minute ago, I’ll just say misguided. Might not quite be the best way to explain it, but it's failed to achieve any real success.
Andrew:
Yeah, well, thanks for laying that out for listeners and for readers of Trivium. Be on the lookout for that report and these videos. We’ll, as they come out, mention them in the podcast, and we'll drop them in the show notes so people can know where to find them. And then, of course, readers of Trivium will get them in their inboxes as well. So, exciting stuff on that front. But back to the topic at hand — I think a lot of the things we're touching on, again, get back to the heart of the challenge of China's economy right now, which is supply demand mismatch. The supply side of the economy is humming, humming, humming. The domestic demand side of the economy is lackluster.
That leaves this huge tidal wave, tsunami, whatever people want to call it, of exports to go abroad. And, of course, foreign policy makers are complaining about Chinese overcapacity. The irony is that I believe in late 2023, the Chinese identified overcapacity, which we've talked about on the pod as a key issue, that they need to address — That overcapacity issue has morphed into what the Chinese, or the issue of overcapacity has morphed into what Chinese leaders call involution-style competition with price wars in the NEV sector. You see price wars in even the food delivery sector, which, by the way, I will note, is good for consumers.
Our colleagues in China are always like, yeah, we keep moving apartments because I can get a bigger place for cheaper each year. And NEVs are inexpensive and I pay next to nothing for food delivery. So, some of this can be good for consumers, but it's unsustainable. It's bad for corporate profitability, which, ultimately, corporates are the ones who are paying the wages of workers. So, things are all tied together. And we've seen a series of kind of commentary on the need to address involution-style competition over the past few months. And they also talked about this at the Politburo meeting. Right, Dinny? Talk to us about the latest thinking here from senior policymakers in China.
Dinny:
The sort of way that they were talking about it was that… what were the words I used? They were talking about cracking down on excessive competition. So, competition is all well and good. But, in this sort of like beggar thy neighbor race to the bottom kind of competition, particularly, is the sort of stuff that you were talking about there in the food delivery business, that sort of stuff we shouldn't have to put up with anymore. They talked about promoting capacity governance, which sounds like a euphemism for plant closures. So, we'll see if that actually happens. And they also talked about reining in local government incentives that encourage overbuilding. Now, this has been a big bugbear of central authorities for a while. Broadly, overcapacity falls into two categories, like one, on one hand, it's kind of the stuff that's a fallout of the collapse of the housing market.
There is never going to be, again, as much demand for steel and cement and glass and probably excavators, and really anything related to the housing market construction industry ever again. But on the other side of the equation, you have a whole lot of overcapacity, which is really being driven by the state itself, particularly local governments hearing Beijing identify strategic industries that need to be developed and then sort of blindly pursuing or promoting industrial capacity in those areas.
And so, it's kind of, on one level, it's policy driven or at least politically driven overcapacity. And so, Beijing gets annoyed at local governments routinely on that front. And they've sort of tried to jawbone them into not doing it, perhaps reducing capacity, but clearly, they've got away with it. And so now the Politburo is like, “Okay, we're going to have to go after the incentives that the local governments have put in place that result in this overcapacity.” Now, of course, the question then becomes just how aggressively do they go after this? I mean, that's really the question because whenever you're dealing with overcapacity, I mean, what we're really talking about is closing factories or, at the very least, having factories run at a fraction of the capacity, which, firstly, has implications for employment. And it also has implications for local government revenue. Because local governments own revenue, particularly VAT, from things that are produced and sold locally.
So, any move they make to deal with overcapacity is going to be political by its very nature. Who bears the costs, which local government bears the costs? So, that's kind of where we are at the moment. I think we have to kind of take the Politburo statement as a statement of intent, and now it's just a question of how hard they go, what measures they pursue, at what period of time does it take to put together a plan, and just how much political pain are they willing to accept as they put together a plan?
Andrew:
Thanks for that. And I think it's important to note that among our clients, specifically in the investment space, you know, sort of global macro investors have really started to take notice of this “anti-evolution push” among Chinese policymakers with several high-level statements on it, some more specific statements and plans coming out of, for example, the National Development and Reform Commission – NDRC. And I think a lot of people are wondering if this is going to be similar to the 2015/2016 timeframe, which is when China introduced the supply side structural reform, which, just quickly, in that time frame, 2015/2016, they were at the tail end of another sort of overcapacity binge, three or four years of ongoing upstream deflation, entrenched debt levels among, especially SOEs, especially in the upstream sector like cement, steel, things like that.
And they pushed forward sort of that deleveraging campaign. They tried to at least cap, if not reduce, capacity in some areas. They even talked about putting consortiums of different industries, of different companies within specific industries together, like cement, to buy up sort of outdated capacity and shut it down. And we've seen at least one hint at that with the polysilicon industry leaders coming together and saying they're going to put together a 40 or 50 billion renminbi fund to buy up outdated capacity or buy up smaller capacity and basically mothball it.
And, by the way, that program in 2015, 2016 was very successful at sort of reflating the economy, getting industrial prices up, which then boosted industrial profitability and helped to cap debt levels. That was also partly part of the reason that was able to work was it was came in tandem a reflating or a re-infusion of cash into the property sector. Right? Which helped to soak up a lot of the excess capacity. Dinny, where do you stand on, you know, is this anti-evolution push a replay of the 2015, 2016 kind of reflationary trait that we saw at that time, or is this going to be something different?
Dinny:
I think it's going to be something different for exactly the reason you just gave. I mean, back in 2015 and ‘16, I could afford to take hard decisions because they still had the property sector and they still had the property sector to fall back on, and they could still lean into infrastructure investment. Sure, local governments were already heavily indebted, but they were willing to continue to let them borrow. Right? So, 2015, ‘16, that was still, what? Four years before they decided to call time on the property sector? So, there was still kind of a sense that the key drivers of the economy — construction, housing, infrastructure — it still had a period to run. And so that gave the wiggle room when it came to hard reforms. This time, that doesn't exist.
So, if they do manage to start to rein in excess capacity, that'll be great for the survivors of the industry, right? I mean, that's ultimately really what the EV, the electric vehicle industry really needs at the moment. You’re kind of in this moment where some very clear industry leaders are starting to emerge. What really needs to happen next is for them to become profitable so they can pay taxes and they can start paying their staff more, and they can kind of do all the things successful companies can do. But, as long as overcapacity exists, they're going to be operating on wafer thin margins. So, yeah, I think for Beijing's sort of grand vision of building an industrially advanced, innovative economy that's moving up the value chain, what ultimately needs to happen is that those firms need to become profitable, and the only way to do it in the current environment is to weed out the excess capacity.
So, it needs to happen. But doing it under the current economic conditions will be painful, particularly given that this time they’re flying without a net.
Andrew:
I don't think it'll be reflationary in the same kind of overall way as we saw in 2015, 2016. I mean, my sense is that they are getting a little bit more serious about certain pockets like the polysilicon industry, solar industry generally, maybe some stuff in the battery industry, potentially in EVs. And so, I think there will be some policy moves that come out that do material impact prices and the sort of state of growth.
Now, how those all come together, I think, remains to be seen based on the specifics of policies to come out. But I do think investors are right to be watching these statements and these policies because I think when supply side structural reform came out and everybody poo-pooed it, I think probably even including myself, but then it really was impactful on how the economy grew and the profitability of various industrial players. So, we'll be keeping a close eye on that. It's hard to predict exactly how things will play out until we see some of the more specific plans, but it certainly is important, I would say. And then another big question is what happens, as you said, to all the workers if they do start shuttering some capacity?
I remember, I'm not sure if I said this on the part before or not, but during supply side structural reform, you would see cities making announcements that, you know, today 100,000 steel workers became DiDi drivers. Right? DiDi was soaking up all this extra capacity is, supposedly, right? That was the — “We've retrained these people to drive cars.” It all seemed very strange, but it will be interesting to see, when you think again about investment, do policymakers call on the big tech companies, try to soak up some of this excess labor capacity if they push forward some consolidation, does that negatively impact profitability of some of the Chinese tech companies?
Do all these employees in the solar space, or whatever, become gig workers for Pinduoduo or whoever, you know, doing food delivery and other types of consumer goods delivery? It's a complicated question. And so, a lot of moving dynamics and a lot of moving parts. And, again, we'll be waiting to see some of the specifics before we start to think through what the actual implications will be. But, certainly, an important thing to watch. Last thing, though, Dinny, before we wrap up is just, so Politburo says the economy is doing okay. We generally agree with that assessment — Talks through the strengths and weaknesses in the economy, talked through the big glaring contradiction at the heart of how the economy is performing right now, which is overcapacity, involution, the supply demand mismatch.
Last piece in terms of takeaways from the Politburo meeting, what do you think comes next? It sounds like, overall, they're not signaling any major policy adjustments. But, still, what do you think second half of the year looks like in terms of economic policy?
Dinny:
I think it's going to be a snooze fest. I think it was quite interesting at the beginning of the year when it came to monetary policy, for example, signaling was really clear – we're going to have a cut. We're going to cut rates; we’re going to cut reserve requirement ratio. Politburo has a meeting at the end of April. Says we're going to I think, what was it? Accelerate monetary policy. I forget the actual wording, but it was pretty clear that there's going to be some sort of loosening. And just over a week later, we got a cut at the policy rate, we got a cut at the reserve requirement ratio. We got two new relending facilities at about a trillion renminbi to boost services spending and innovation investment.
It was signaled, or if not, the specifics and the tone of what was coming was, you know, none of this ended up being a surprise. This time around when it comes to monetary policy, the PBoC put out a couple of notices over the last few weeks. I mean, the subtext is like, oh, wait, we're going to consolidate and I make the most of the measures we rolled out in the first half of the year. Really, I'm not expecting anything at the moment in the way of monetary policy. If we get a cut of any sort towards the end of the year, it's because they reappraised the state of the economy. But at the moment, I think they have no intention of cutting or further loosening. As for fiscal policy, I think Beijing sort of entered this with the expectation that it was going to be a tough year.
And so, they increased the target budget deficit from 3% to 4%. I mean, that's a big deal. It's been 3%, below it for 30 years. So, this was a big deal. They increased the quota for special treasury bonds and special purpose bonds. Just the overall picture was like, we are going to spend, we're going to borrow more as a government this year. And the subtext was the state of the economy's going to be a little bit more challenging. And yet, because of the state of the export machine, achieving GDP targets haven't been as difficult as anticipated. So, they haven't had to roll out more stimulus. They haven't really even had to accelerate the implementation of their existing spending plans.
I mean, in April, the Politburo said, “We will bring forward our fiscal spending.” And then when they announced the bond issuance plan, they brought one bond forward a week. They brought another one forward two weeks. I mean, yeah, they accelerated issuance, but not in any sort of way that's going to have an impact on the economy in a meaningful way. So, I think that's kind of where we are. I think Beijing is pretty happy with the way things are going. It doesn't feel compelled to further loosen monetary policy. It doesn't feel compelled to either provide additional stimulus or even accelerate its spending plans. It's going to wait and see. And it's not waiting to see because it thinks things are going to go really bad. It's waiting to see because things are going pretty good. And it's probably going to require something unexpected for them to change their overall direction.
Andrew:
Yeah. I will say a couple of things. One is I'm interested to see whether they re-up some support for the consumer goods trade-in program in the fall. I mean, it's expected to basically run dry in September as far, as I understand. And so, if consumption really starts faltering, I wonder if they might re-up of some money there. And then they always have the option to add some more bond issuance capabilities for local governments if infrastructure spending starts to fall off at the end of the year. And a lot of times, that's happened for the past several years because most of the bonds are required to be issued by the end of October. And then you kind of have this whole fiscal spending in the last part of the year. I would say if they do re-up on some special purpose bonds for local governments, that wouldn't necessarily be a sign of panic or necessarily stimulus per se.
But it might just be like, okay, they have a little bit of a fiscal hole that we need to plug through to the end of the year. Those are the two things I'm kind of looking at to see if they might offer a little bit of sort of renewed support. Again, I wouldn't call it stimulus, but just kind of plugging a couple of holes. And then the last thing that I would kind of highlight is, to your point about things are going better than they thought they might be, is the U.S.-China negotiations seem to be pretty on a relatively positive trajectory. So, we've known that they kind of wanted to hold a little bit of a firepower throughout this year in case the new Trump administration really went after China.
Obviously, things didn't look great in the April to early May timeframe. But now it looks like trade with the U.S., while contracting, might stabilize at a level that's at least better than the most dire circumstances that could have been put forth. So, that's another thing that kind of might keep them from having to go back to the well on significant stimulus. But if that turns and things go badly, they do have firepower. The point is just that, on a relative basis, U.S.-China negotiations seem to be somewhat productive. And maybe they didn't expect that to be the case at this point. You agree?
Dinny:
All right. That sounds great to me, mate. Yeah.
Andrew:
All right. Well, so I think basically the upshot is we are looking at kind of a snooze fest on economic policy for the rest of the year, which actually are at least an economic policy that's largely on cruise control, which I guess Chinese policymakers will largely be happy with. We will be, of course, covering all the ins and outs, the ups and downs as things unfold. You never know which way it's going to turn. But for now, I guess our general assessment is not all that different from where Chinese leaders are thinking, which is actually this is economic performance we can live with. So, we'll see if it changes. But for now, we'll leave it there. Dinny, thanks so much for the time. It's great to have you on the pod again as always.
Dinny:
Yeah, absolutely, Andrew. It's been great to be here.
Andrew:
Yeah, thanks. We covered a lot of ground as always, and thanks everybody for listening. We will see you next time. Thanks, everybody. Bye.
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