It’s been another consequential week for China’s economy and foreign policy – with Beijing deploying its blocking rules for the first time ever in response to new US sanctions tied to Iranian oil purchases.
On the first half of this week’s Trivium China Podcast, host Andrew Polk is joined by Trivium’s Head of Supply Chain and Critical Minerals Research Cory Combs to unpack what China’s latest legal and regulatory moves mean for the future of US-China economic competition and sanctions enforcement.
The two discuss:
China’s first-ever use of its blocking rules
Why Beijing reacted so strongly to new US sanctions on Chinese refiners
The growing risks facing banks and firms caught between US and Chinese legal systems
How China’s broader counter-sanctions toolkit is evolving
Why uncertainty itself may be part of Beijing’s strategy
Then in the second half of the pod, Andrew is joined by Trivium’s Head of Markets Research Dinny McMahon and Lead Macro Analyst Joe Peissel to break down the latest signals from China’s economy following a surprisingly strong Q1.
The three discuss:
Why China’s economy outperformed expectations early in the year
How the Iran war is affecting inflation, exports, and industrial costs
Beijing’s renewed push on infrastructure investment
Why consumption remains the economy’s weakest link
Whether China’s export machine can continue powering growth through the rest of 2026
Together, the conversations offer a timely look at how Beijing is navigating mounting geopolitical pressure while trying to keep the economy on track.
Transcript
Andrew Polk: Hi, everybody, and welcome to the latest Trivium China Podcast, a proud member of the Sinica Podcast Network. I’m your host, Trivium Co-Founder, Andrew Polk, and today I am joined once again by Trivium’s Head of Supply Chain and Critical Minerals Research, Cory Combs. Cory, how are you doing, man?
Cory Combs: Well, good to be back.
Andrew: Yeah, always good to have you. I’m having Cory on again for his second go around recently, or a quick return to the pod, primarily because we want to talk about China’s first-ever use of its blocking rules to counter U.S. sanctions on Chinese companies, which took place on Friday after the U.S. sanctioned some Chinese companies tied to purchases of Iranian oil. We’ll talk about that. We’ll talk about what it means for the future of sort of economic coercion and economic competition and warfare, if you want to call it that, between Washington and Beijing.
After Cory and I speak, this is the first half of the pod, I’m going to speak to our Head of Markets Research, Dinny McMahon, and our lead China Macro Analyst, Joe Peissel, about the latest on the macro economy. So, listeners will want to stick around for that in the second half of the pod. Two very interesting conversations and very timely. So, we’ll cover a lot of ground today. But before we get into all of it, we have to start with our customary vibe check. Cory, how’s your vibe?
Cory: I’m excited. There’s a lot going on right now, but I’ll be in Philly for a conference here shortly with the Penn Project. I’ll be doing some other just kind of interesting subnational work over the next few months. And so, it’s nice personally, I’ll just say, to have, in the midst of all this kind of big picture statecraft stuff, to also have some sub-national engagements, trying to move the needle forward on clean tech and a few other things of personal passions of mine. So, yeah, it’s a lot going on, but it’s a good time.
Andrew: Nice. Glad to hear it, man. Well, I, for my part, I’m feeling pretty energetic. I think I talked about this last week when Kendra was on the pod, but just kind of a lot of good things cooking with the business, which I’m really pumped about, which is awesome. And kind of simultaneous to that, I am, after years, I’ve been a runner for a really long time, but I’ve also been a business owner for a really long time.
And the business owner, the unhealthiness of being a business owner has offset the healthiness of being a runner or has outweighed. So, anyway, I’m back into running. I’ve been running a lot in 2026. I did a 13 miler on Saturday. First time in a while. I’ve done basically just a half-marathon on a Saturday. So, racking up the miles, feeling good, getting kind of my speed back. Anyway, people who are out there who are runners will know what I’m talking about. When you kind of hit a little bit of a groove, it’s really good.
Cory: Just a little humble bragging. I love it.
Andrew: It’s not a humble bragging. That’s for runners. Yeah, I mean, well, that’s not what I meant for it to be.
Cory: Not at all.
Andrew: All right, all right, all right. I’ll own it. But my point is I think a lot about running and the discipline of running and how it feeds into other parts of my life, including running a business and being a researcher. And, honestly, like most days, it’s just a boring slog when you’re running, and research is the exact same. And then every once in a while, you have this like, you know, really great run or race or something, you know, you publish a paper. And so, it’s just like miles and miles of slog with the staccato of actually, really, really exciting moments. So, I don’t know.
Cory: That’s great. We take the wins. Absolutely.
Andrew: Yeah. Anyway, that’s the energy I’m bringing to my life and this podcast in particular. So, everybody better strap in. All right. That was an extended vibe check. Hopefully, we still got our listeners with us. We’re going to get into the meat of the discussion in a second, but we also have to do the housekeeping real quick up top. Just a quick reminder that we are not just a podcast here.
Trivium China is a strategic advisory firm that helps businesses and investors navigate the China policy landscape. That, of course, includes policy towards China out of Western capitals like D.C., London, Brussels, and others. So, if you need any help on that front or on following domestic Chinese policy and analyzing domestic Chinese policy, 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 are interested in receiving more Trivium content, check out our website. Again, triviumchina.com, where we have a bunch of different subscription products, both free and paid. You will definitely find the China policy intel option that you need on our website. And finally, tell your friends and colleagues about Trivium, both about the podcast and the company. Like I said, we’ve got a lot of really good things going at the business. We’re growing. And a lot of that’s because of our listeners either engaging us for work or telling others about us. And those word-of-mouth recommendations really mean a lot and help us grow the business. So, with that, well, let’s just jump straight into it here, Cory. We’re talking about the blocking rules and China’s use of them. But why don’t you just set the table very basically, set the stage. What happened here? Walk us through the details.
Cory: Absolutely. So long and short is China has issued or deployed its blocking rules for the first time. And these are rules that were set up in 2021. They’re part of China’s broader counter-sanctions playbook. But this is the first deployment of them. And so there’s a lot of industry and political attention, both geopolitical attention, on what these are and how they might be used moving forward. So this is really the question mark. There is no precedent. This is the first issue. So, I’d like to give just a little bit of context of how we got here.
The proximate trigger here was that OFAC, the Office of Foreign Assets Control, sanctioned Hengli Petrochemical for its role in importing sanctioned Iranian crude. Now, there’s a bit of other context here, as folks watching the media coverage might be aware, OFAC is sanctioned for what are known as teapot refineries for other Chinese refineries over the last year. They started in March or April of 2025. And we saw a series of four different separate sanctions last year.
Beijing did not deploy a meaningful playbook against that, seems to have tolerated those actions. But on April 24th, we saw OFAC designate Hengli for sanctions under an executive order there. And in addition to Hengli, there were 19 Shadow Fleet vessels and about 40 affiliated shipping firms. There’s a number of other entities here, but the real focus is st Hengli refiner. In response to that, and in the broader provocations here, MOFCOM on May 2nd announced the deployments of the blocking rules. This is the first deployment again since they were issued in 2021.
Andrew: Okay, thanks for laying out those details, but it still sort of leaves a question open for listeners, what exactly are the blocking rules? Can you kind of tell us exactly what they do so that listeners can understand kind of the mechanism here?
Cory: Absolutely, exactly. So the formal name, and listeners will realize why we use the short name, the formal name is the Provisions on Counteracting Unjustified Extraterritorial Application Of Foreign Legislation and Other Measures. So, mouthful, but very clear about what this is. Basically, where Beijing deems that you have taken extraterritorial actions that unduly harm China’s interests, they reserve the right now to push back on that and to say, “You’re not allowed to comply with the foreign sanctions.” So, in this case, what the blocking rules are doing is saying that you are not allowed to comply with the U.S. sanctions on Hengli, on the refiners, or on the vessels in the Shadow Fleet, etc.
So, this is a very direct way of saying Beijing not only has the ability to issue its own sanctions, but to block, at least theoretically, it’s saying it has the authority to block the execution of other countries’ sanctions. This is loosely modeled on the EU blocking statute. There are differentiating factors, of course, but basically, yeah, it’s a prohibition on foreign measures. So, there are a few kind of factors here I think it’s worth noting. One is who does it apply to? Technically, it applies to anyone in China, and that includes foreign actors, right?
So, anyone involved in China can, or working in China, operating in China is not allowed to recognize, enforce or comply with, as the official language, the named sanctions. The other really two interesting pieces of this, one is that there is flexibility. And I’d say there’s more flexibility here than some of the other sanction toolkit measures as well. The first is that you have an exemption mechanism. So, the way all the blocking rules will work is that the Ministry of Commerce, MOFCOM, has to conduct an investigation to say, “Were these extraterritorial rules undue, unjust?” So again, there’s the names is unjustified extraterritorial application of foreign legislation.
This isn’t about anything that affects anything the U.S. does extraterritorially. It’s only if it’s considered unjustified. That explanation lies with MOFCOM. And specifically, a major piece of how MOFCOM is looking at this, there’s obviously the geopolitical angle, but at a technical level, Does it harm sanctioned Chinese parties in a way that is considered unjust? So, what’s the two pieces of the mechanism that allow for flexibility here? Basically, if you have certain interests, you can apply to MOFCOM for what’s known as an exceptional hardship exemption.
And basically, you can argue to MOFCOM that, “We’re not able to not comply with the U.S. sanctions. Please allow us to comply with the U.S. sanctions,” without also then getting countersanctioned by China, right? So, there is technically an escape valve here, the exemption mechanism. On the flip side, if you are a sanctioned Chinese party, you, under the blocking rules, have the right to sue entities that do comply with the sanctions that harm your interests in Chinese court. You can sue them for damages. So, this is going to be one of the dimensions of the implications. So, there are several, but this is going to be one of them.
This is not something we’ve really seen happen. So, a lot of the implications, I think it’s going to be a lot of very interesting legal analysis to come out of all of this. But so again, you can apply for an exemption or you can, in principle, sue a foreign actor who, or technically a Chinese actor, I guess, too, who is complying, who harms your interests. So, broadly speaking, the blocking rules are at least billed as, and I’m sure we’ll get to how this fits in the broader picture, but broadly, this is billed as a defensive mechanism.
It’s billed as a way to protect Chinese interests. And part of that means that Beijing has to allow for that flexibility so that it doesn’t just automatically, by definition, hamstring all Chinese actors with significant U.S. exposure. At the same time, it is a very clear statement of we can reduce the impact and we can directly interfere with the imposition of foreign sanctions, specifically U.S. sanctions. That’s what this is all about.
Andrew: That’s interesting. You made a point that this only applies to legal entities in China, is that right? So, it’s not a mechanism for extraterritorial jurisdiction by China. It’s jurisdiction, I guess, right?
Cory: That’s my understanding of it, yeah. And I’m sure, I mean, I’m sure that there will certainly be extraterritorial, you know, implications, right? If you’re a foreign actor operating in Hong Kong, one really interesting piece here, actually, is as far as I understand, as of recording, there’s still a little bit of uncertainty around the role of Hong Kong. Is Hong Kong in scope or out of scope? The May 2nd order didn’t, to my reading, make that super clear. In dome discourse, maybe that was deliberate. Others, Maybe it’s, anyway, to come. But yes, in general, yes, it’s really to defend China against imposition from abroad, not going abroad in this case.
Andrew: Helpful. Cool. Thanks. So I wanted to pick up on, you mentioned, interestingly, I think that these rules are sort of defensive in nature, which I agree with, right? as opposed to sort of the more offensive pieces of the legal toolkit as we kind of think about it, which would be export controls, anti-foreign sanctions law, unreliable entities list. But how do you think about it in terms of how these blocking rules fit into the wider lawfare toolkit that China has been developing over the past close to a decade?
Cory: Yeah, it’s actually almost exactly a decade. Yeah, the National Security Law, I believe, came out 2015. Is that right?
Andrew: I think that’s right.
Cory: Yeah, that was the legal foundation for all of this. It took a few years. I mean, the unreliable entity list appeared in late 2020, I believe it was September 2020. But yeah, so we’ve been seeing the buildup of this toolkit for a while. So the way I would frame it, and there’s probably other ways to conceptualize this, but my framing for now, I mean, one piece is clear, the NSL, National Security Law, is the underpinning of this, right? It’s the legal authority for China to sanction, counter-sanction, right? The main three pieces that I would flag, you’ve already listed, right? There’s the unreliable entity list. Effectively, this is a trade and investment blacklist or restrictions list, that’s outward-facing.
That’s actors who are flagged as, well, unreliable, that China is basically blacklisting. You have the Anti-Foreign Sanctions Law, which is, again, as the name very clearly indicates, sort of countermeasures, right? This includes asset freezes, visa bans, things like this. Again, it’s more outward facing, though. It’s looking at actors abroad who are affecting China’s interests. But then you have the blocking rules. They’re very inward-focused. And basically, what they do is they claim the authority to void foreign sanctions within China, basically a private right of action.
So, that’s how I would kind of pitch those. And across those, you see, basically, this maps on pretty, you know, not one for one, but in terms of function, we see a pretty clear mapping between U.S. and EU capabilities for sanctions, counter-sanctions. China has been building up the playbook to be able to match or in some cases exceed those authorities across various tools. And this is the piece that I’d argue is more defensive in nature, but it really helps round out the toolkit within China.
Andrew: Yeah. And I mean, we’ve been following this very closely as a company. I’ve been writing and analyzing all these moves out of China a lot for the past several years for clients. And I wrote a paper with Evan Medeiros a year and a half ago. Maybe it was just a year ago. I forget. Anyway, but kind of documenting just the pace, the accelerated pace with which all these tools are being used — Anti-Foreign Sanctions Law, Unreliable Entities List. Obviously, the export control regime, since April of last year, has come fully into force. But each of these tools is being used more aggressively, more proactively, more frequently. This just happens to be the first time that the blocking rules have been enforced. I mean, what do you make of the timing of that?
It’s obviously in response to the latest sanction, but is there anything broader to read into the timing from a strategic point of view, or is this just a tactical reaction to what the U.S. administration did?
Cory: Yeah, I mean, like so often, I feel like the answer is probably both and more. But there’s a few key pieces to unpack here. Absolutely. So one additional bit of context for diving into some new points is this is approximately about Hengli and refining, right? This is about the sanctions on China’s use of Iranian oil. From the U.S. perspective, this is ostensibly about Iran, at least officially speaking. And from China’s perspective, obviously, this is U.S. policy toward China in this case, right? So, there’s that kind of perception gap. And not that either side is completely unaware, but I think the framing is broadly in those different camps, so to speak.
The other context here is that mid-April, this is just over a week before the actual sanction on Hengli, Secretary Bessent, Treasury sent warning letters to two unnamed Chinese banks, warning about secondary sanctions exposure to transactions, right? So before it was Hengli, we have a very clear indication of, hey, your banks might be embroiled in this, and heads up, right? So, I think that is one critical piece of information. We also then need to talk a bit about China’s refining industry. We need to understand more, like, what is the playing field we’re operating in? In this case, it’s the refining industry. And so, there’s some critical details there that I think the White House’s own language budged a couple of things that are really important nuances to understand in China’s refining industry. So, I’d like to make those clear. But broadly, it’s not just about the oil. It’s also about the bank exposure as well.
Andrew: Yeah, well, we’ll come back to like whether or not China is going to sort of roll out these, what the timing means, and whether or not China is going to lean more on the blocking rules going forward in terms of, once we talk about the implications. But before we do that, you’re right. We should talk about sort of the bigger context of the refining industry and sort of how that fits into this story as well. So why don’t you go ahead and do that for us?
Cory: Yeah, absolutely. So we won’t wonk out too much, but a little bit. There are two or three, depending on how you define it. I would argue there’s kind of three parts of China’s refining industry. There’s the state majors, where you’ve got SINOPEC, CNPCC, the state refiners are massive. They’re massive global actors, they’re obviously massive Chinese actors. They dominate China’s refining capacity. They are global actors. They have incredibly deep, unavoidable, inextricable linkages to the dollar system. They can’t really not work within the USD system. And so they tend to comply with U.S. sanctions. And Beijing is not going to get in the way of that at this point. It just can’t. Then you have the independent refiners. And this is where I want to make a critical distinction.
A lot of people are familiar, if not before Iran, certainly now, with what are known as the teapots. the teapot refiners. These are traditionally the smaller, we’re talking kind of under 100,000 barrels per day capacity, but smaller entities, mostly in Shandong. They tend to be relatively low tech. They’re very local.
I mean, in Chinese, they’re literally, dúlì liànchǎng, so local refiners. The emphasis there is these are the actors that can absorb in China a ton of sanctioned crude. These are the refiners, the teapots that have bought up sanctioned Russian oil, sanctioned Venezuelan oil, and currently, in very large quantities, A lot of the Iranian crude as well. The notable feature of the teapots is that they have very limited exposure to the dollar. They are able to operate while sanctioned very effectively. A lot of the banks that lend to them, China has adapted. The system has adapted over years of U.S. oil sanctions.
And so you have this, not only the refining industry, but also the financing behind it has been able to adapt to operate, again, at smaller scale, but to be able to operate more renminbi denomination, less direct exposure to USD, fewer liquidity issues in global markets, right? And so, that’s why the teapots are able to basically get away with operating under sanctions. There’s a separate segment of the independents, though, which are what you might call mega refiners. There’s various ways to phrase it, the big boys of the independent side.
These are not what I would call a teapot, right? This includes Hengli. The mega projects are anywhere over 300,000 up to 800,000 plus barrels per day of capacity, of processing capacity. These are world-scale projects. And they’re integrated projects, right? These are not the kind of niche teapot things. These, again, including Hengli, have one, more exposure to the U.S. dollar system, and two, more of a need to participate globally in a global ecosystem. So, there’s deep petrochemical integration across the production chain there, but most importantly, they have major credit lines with mid-tier Chinese banks, which do have USD exposure.
That is where this becomes very different from the teapot. The official U.S. language says teapot refiner, Hengli, I would say that’s a mischaracterization because again, the teapots can operate in a sanctioned environment. Hengli is going to have a much harder time, specifically the banks that backstop Hengli. So, going back a little bit to that first question, or the first two questions — one, what happened in the background? We have four genuine teapots got sanctioned last year, throughout 2025. Shouguang, we’ve got Shengxing, we’ve got Jincheng, we’ve got Hebei Xinhai, I believe it was. You didn’t see much of a reaction, and I doubt most people have seen those names in reporting unless they’re specialists, right?
And then you get one sanction, suddenly huge reaction. Why? This is why. It’s that exposure. So yeah, so happy to talk about kind of Hengli in more detail. A bit of interest, but that’s the key point here.
Andrew: Yeah. Well, tell us a little bit more about Hengli itself. Why do you think the U.S. administration took such an interest in that company specifically?
Cory: Yeah. So, there’s a few of the mega projects or mega refiners, Zhejiang Petrochemical, the biggest ZPC is known, it’s one of the biggest complexes in China, and the biggest of the private refineries by far. Number two is Hengli. This is the second biggest private refiner and mega project in China. It’s ahead of Shenghong, which some other folks working in this space will be familiar with. Specifically, Hengli is, of these, the one that has certainly the most direct involvement that we can trace in purchasing sanctioned Iranian crude. Now, a lot of the Iranian crude has been, let me put it this way, if you look at the trade data, things don’t add up, right?
And so what we’ve discovered through a lot of satellite analysis and others, there’s specialists in this who’ve been tracking the flows, and what appears to have been happening is a lot of relabeling of Iranian food off the coast of Southeast Asia, a lot of “Indonesian oil” crude coming in. Hengli is buying a lot of that. So, there’s a direct cause and effect here. I think there is a technical a credible foundation here for why Hengli specifically was targeted. But again, it does not operate the same way as the teapots who have been absorbing a lot of capacity.
It’s also important to note how, you know, we have this question of USD exposure, renminbi settlements, and this ties into sometimes that Dinny has talked about as well, it’s like are we moving to de-dollarization in oil markets and stuff like that? And it happens at the margins and certainly it happens a bit, there’s a lot of renminbi-denominated deals in the oil and gas industry when it comes to sanction actors. But the critical thing is you cannot do that at scale without the U.S. dollar. So, when you’re the size of Hengli, you are dealing with the dollar, and certainly the banks you’re dealing with are big enough that they’re also dealing with offshore investment, with overseas exposure, etc. So, there’s a lot of USD exposure there as well.
Andrew: Okay. Well, I mean, speaking of the exposure, why don’t you walk us now through what you think some of the impacts of both of these movements are, both the sanctions by the U.S. government and maybe even more so in particular, the blocking rules, the imposition of the blocking rules by the Chinese side, because a lot of times, especially in the run-up to this meeting between Xi and Trump, right? The Chinese, I think, in general, obviously, not obviously, but they feel like they need to hit back against sort of any move by the U.S. And that’s especially true, which we’ll get into a little bit more in a minute about the context with the upcoming Xi-Trump meeting and how that all fits in.
But they particularly feel like they have to retaliate or at least react to everything right now that the U.S. does. But a lot of times they do that just more out of a symbolic, like we want to register our displeasure. And sometimes it’s an actual thing that matters, like in the real world, like the export control. So, if the export controls is the extreme thing, and shaking your fist at the kid on your lawn is the symbolic thing, where are we on that spectrum?
Cory: Yeah, absolutely. The shaking your fist side might be the investigation China has into U.S. clean tech protectionism, which is very symbolic because it doesn’t actually change much of anything. There’s not much of an industry to reshape right now. So, I think it is a good example of the symbolic side. But yeah, so in terms of impacts, yeah, let’s break it up. We have the Chinese actors. Obviously, there’s the impacts of the sanctions, which I think we’ve talked about enough, but the impact of the blocking rules on the Chinese actors. And then I think of concern to a lot of listeners is going to be the direct and second-order impacts to non-Chinese actors. All of this, I think, flows through the banking side, right? The first thing to note is coming back to earlier, You know, I noted the exemption mechanism.
A natural question, I think, should be or would be, is every bank exposed to oil and gas in China at risk of being counter-sanctioned? No, not really. I think, first of all, there is specialization within the banking industry. And generally speaking, what we see is mostly a lot of the banks that are directly involved in this industry, the parts of the industry that, you know, engage with Iranian and other sanctioned crude tend to be the mid-tier commercial banks. Critically, and I should have probably just said this up front, it’s not the big four. It’s not the central bank. It’s also very, very, very likely, in my opinion, that the big four will seek exemptions and probably get exemptions from MOFCOM so that they can formally comply with U.S. sanctions.
Again, the exposure is too much it’s not worth actually blocking them from complying because the implications for china are simply too big. So, really what’s going to happen, I think, is a squeeze on the, or is happening, is going to be a squeeze on the mid-tier banks. Now, I should know, why do I say will happen, not is happening? Because, technically, OFAC provided a 30-day window, right? So they have a month basically to wind down any support for actors involved in sanctioned activity, so Hengli and others and the refiners. So, technically, they have until, as of recording, a couple more weeks until full implementation, right? So this is coming.
I just want to note that as well. But here’s one of the issues with the mid-sized banks or for the mid-sized banks. And I think it’s not just an issue for the banks. I think this is arguably why, part of why Beijing has taken this case so seriously, the exposure of mid-tier banks seriously, most mid-sized Chinese banks are broadly exposed to the dollar, both directly and indirectly, right? Directly through off-tour accounts and indirectly through derivatives, Hong Kong, etc. As I noted, the small refiners can use renminbi, but you can’t settle the amount of crude imports that Hengli processes without, you know, kind of going into the USD system.
So, those banks are exposed to both renminbi-settled and USD-settled trade. The punchline of all this is the midsize banks need USD liquidity. These are the funders, they need USD liquidity. On the flip side, they can’t just stop supporting the refining industry. I mean, apart from the fact that it’s lucrative, Beijing has a vested interest in making sure that these non-state, these private refiners continue to process the cost-effective oil, There’s a huge refined products and a petrochemical fuel export sector. It’s very significant for China’s exports as well as domestic consumption.
So, refined products and fuel exports. So, you’re not going to see these banks just pull back from the sanctioned activity. They realistically can’t, but they still need USD liquidity. So, this is where this potential for a squeeze comes in. We have already seen that US activity has changed the risk calculus for these mid-tier banks. We’ve seen, for example, cross-border lending has decreased over the last few years due to heightened risks, but they still need that liquidity. Right now, the more they’re sanctioned, the less liquid they become, or at least the risk becomes that they lose that liquidity. These are not banks that have… you know, they don’t have nearly the diversity of funding and revenue that the big four have.
They are much more vulnerable to USD liquidity issues than, say, the big four. So, this is not to say, you know, there’s an immediate risk of financial contagion from the mid-tier banks. But this is the kind of thing that Beijing, I would have to presume, I think reasonably, look at and say, this is the kind of thing that leads to a liquidity crisis in your mid-tier banking. And there is the potential for broader issues. So, I think that’s part of what China takes very, very seriously about this.
Andrew: Well, I mean, so do you think the U.S. sanctions are going to have that kind of impact? Or is this, everything you said, correct me if I’m wrong, is sort of this could happen if they are squeezed this hard? They could also just pull back some of their lending to some of the refiners, potentially. I mean, what are their options here? And I guess the question I’m trying to get at, yeah, how bad is this for these guys?
Cory: Yeah, first off, I agree. This is not an imminent crisis at this point. I think part of the response is to say, you’ve pressed a button, right? This is not what you might call a mere political concern. This is the type of thing that can become a real problem. And so I think part of the signaling exercise is to say, “Look, we take this very seriously.” Like this is not imminent crisis, but we take this issue very very seriously, and if we continue in this direction, we will make bigger moves. I think you know in terms of realistically for this particular case, I do think there’s flexibility.
I think you’ll see a lot of finagling financing to make sure that everything gets what it needs to operate. But again, it’s the principle behind it. With a lot of the true teapots, the teapot sanctions, they don’t really affect that much. They’re largely political. They’re signaling. This is a change. This is a type of thing that was characterized as a teapot sanction. That is not what I would call an actual teapot sanction, right? It has potential. So that’s the bottom line. This is a different type of provocation. And so it’s a different type of response.
Andrew: The timing issue. So, it sounds like the response is sort of because, well, I guess there’s a bunch of things here. I mean, let’s talk about this in the context of the Xi Jinping-Donald Trump meeting next week. Is this a big enough deal to derail the meeting? It doesn’t seem like it to me, but you’re kind of making the case this is sort of a step change in the sanctions regime. Now, I would say, my guess, this is not inside knowledge, but my guess is that this is not a move by the Trump administration aimed at China per se. It’s aimed at the Iran war, right? It’s aimed at Iran.
Cory: I agree.
Andrew: And in the administration’s mind, those are probably two separate issues. And China’s sort of collateral damage. Of course, it’s aimed at China insofar as they are supporting Iran, but it’s not in their mind part of the direct to U.S.-China sort of economic negotiations and all of that stuff. But in China’s mind, it absolutely is, I would surmise. So, anyway, just talk to me about what you think about all this in terms of the context of the upcoming meeting.
Cory: The good top-line news is I really don’t see this derailing anything. I agree, I think this is not framed, from the U.S. side, as, you know, this is not being used intentionally, at least as leverage ahead of the summit, in my view. And there are legitimate interest in, hey, insofar as the U.S. is pursuing action on Iran, within that, not commenting on the kind of the strategy here, but within that, given the objectives with Iran, at least the ones that are clear, Chinese purchase of sanctioned Iranian crude directly undermine what the U.S. is doing.
And so it makes sense that the U.S. is treating this like a very kind of just a tactical problem with, you know, its near-term imminent objectives, what it’s trying to achieve in terms of cutting off Iranian revenues there. For China, of course, none of these things are separable, as you say, in political discourse, in the way the behavior speaks, like the kind of revealed preference kind of stuff, it doesn’t look like China’s ever going to separate the stuff, and reasonably so from their perspective given their interest in all this. But the good news is I think everyone is aware of all these things. I think Beijing has demonstrated over the last year, really, of U.S. actions, and understanding that a lot of things are problematic.
And Beijing evidently, again, observed behavior feels the need to push back, but also often is not like trying to derail things with their response. I think that suggests an understanding that the U.S. might be overstepping or mixing issues that Beijing doesn’t want to from Beijing’s perspective, but that Beijing isn’t going to fundamentally derail, you know, certainly the summit, but even a lot of other efforts as a result of it. And for that matter, I think every indication we’ve heard from all quarters is that everyone, generally speaking, both sides of leadership want the summit to happen and want it to be productive, right? So, I don’t see this derailing it, but it is critically important, I think, as a… I mean, the first time anything happens, it always sets the precedent, right? So, I think that’s the critical juncture is this is the first use of the blocking rules.
I mean, this is all we have to go on in terms of understanding when and why Beijing might use blocking rules. So again, top line, we’re okay, not worried about the summit for this reason at least. But more broadly, it’ll certainly come up the question of, you know, there’s a big question – does U.S. need China when it comes to resolving the iran situation and kind of coming to an end of the conflict? Personally, I think yes. How does this all factor in? There’s going to be that kind of strategic discussion, but it’s going to be a broader discussion of which this is a part this is not the main focus of that. This is, though, a major focal point in a separate conversation of China’s evolving counter-sanctions toolkit, if that makes sense.
Andrew: It does. And I’ll just ask you one last question. I mean, I hinted at this a little bit earlier. I mean, I think the timing of this partly is tactical, right? That with the understanding that was agreed to in Busan, China’s strong position is that we have agreed to fully cease all hostilities. And so anything that the U.S. does, even if the U.S. administration thinks that they are sort of operating on separate issues, like in the case of the, I think the sanctions, the secondary sanctions related to Iran, China still feels the need very much at this moment, as I already said, to make sure like, “Hey, we agreed we’re not going to do this kind of stuff. So if you do anything, we absolutely have to match it.”
That said, I mean, there’s reporting by I think Bloomberg today that like officials are telling these banks to kind of pause lending to the refiners. So they’re instituting the blocking rules, but at the same time, encouraging the banks to comply with the sanctions while they kind of figure out the ultimate ramifications. And so that sort of leads me to believe we’re more on the symbolic side of the use of the blocking rules. But I think that’s the tactical piece. But the question then becomes like, in theory, Beijing could roll out the blocking rules, you know, against a host of previously imposed sanctions, right? Like we don’t really know where it will end or where it could end and what the breadth of the use of these new tools will be when and if Beijing tries to pursue them further. What do you think about where that goes?
Cory: I agree entirely. And the challenge with all this stuff is the possibility space is very wide. It’s very large. And all we have to go on is relatively sparse observations, like a low end if you’re talking in terms of number of observations. And you have to make a lot of inferences about what China’s intent is around its reaction function, right? And that’s the hard part. But I think we’ve talked about this in a different context, but I think that uncertainty is part of the playbook. I’ve argued in a couple of different fora that, as much as these tools are the center of the toolkit, but another tool in the toolkit is optionality, right? Beijing leaving itself space to ratchet up or down in position.
If there is a super clear line of when each tool would be deployed, one, it’d be easy to game that line and kind of walk up to it without crossing it. But two, China would lose some leverage. I think a lot of the issue, I mean, certainly the practical challenge for foreign companies, but also the strategic leverage for Beijing is that no one knows exactly how things will be implemented, when, on what basis. And we can, obviously, there’s an extent of uncertainty that becomes counterproductive if it’s just random, like certain policy actions in certain countries can seem a bit random.
Obviously, you kind of lose pull. But if Beijing is able to say, look, here are types of things we don’t like, here are types of ways to respond, we’re not going to tell you exactly how we respond in each particular case. You have the leverage there to say, to basically kind of warn off certain types of behavior, or at least try to. And I think that uncertainty is… there’s also, let’s not, you know, make everything out to be 4D chess. I mean, there’s certainly operational and certainly how this works on both sides. I mean, as you said, I think there’s a lot of, how does this actually materially work?
I think MOFCOM, and others, are probably still working through that realistically. But there is also that strategic element where I do think a degree of uncertainty is strategically useful. A degree, not an excess, and we might be seeing more than is strategically useful, but I think that is part of it and will be maintained forward. What I’m saying is I don’t really anticipate a world in which this is ever completely clear. I mean, it might be worth, just on a final note here, I’d add, I mean, one of the direct implications, among the huge possibilities based on what we don’t know, but one of the direct implications is, as of now, every bank with assets or exposure to China or to Hong Kong, because we don’t know about that piece, insurance markets, right? P&I in the maritime space and transportation, logistics, MNCs with exposure to any of this stuff.
You now have to ask yourself for every relevant OFAC announcement going forward, if it affects China or a certain interest, will China respond with blocking rules? Like, your risk assessment just got more complicated. It’s been getting more complicated progressively over the last few years. Hopefully, this is one of the last major new pieces, I hope, for a little while. Hopefully, the playbook’s pretty clear now, or pretty, not clear, but all the pieces are on the board, so to speak, I hope, at this point. But as of now, if you’re in any of those noted actors, you have to factor in OFAC announcements and the potential for Chinese response, and probably a lot of other U.S. actions as well, and potential Chinese response.
And the critical risk, which you flagged before, a long time back and recently, is the worst case. We haven’t seen it happen yet. We don’t know when it’s going to happen or where it’ll happen, but we’re waiting for it to eventually happen is that some company gets caught in the crossfire, is sanctioned by the U.S., can’t do something, is counter-sanctioned by China, can’t not do something, and you’re done, right? That is the worst spot to be, especially if you don’t know when it’s coming or if it’s going to be your company. So, I mean, if I can make a kind of a pitch to everyone, just from a risk standpoint, as you’re doing horizon scanning, as you’re doing kind of longer term risk analysis and scenario analysis and planning, factor this in, and try to figure out if, hopefully it won’t be, but if through bad fortune, it happens to be your firm, your company that gets pins up between these, how will you respond?
I think having at least a general notion of your risk tolerance on either side is essential. And there is a diagram. We can go back to our favorite grad school two by two matrices, right? And plot, you know, do you have high China exposure, high U.S. exposure, high low on either side or low in both cases, not really relevant. But if we expect the actors with high U.S. exposure, low China exposure to comply with the U.S., reverse it, comply with China. If you’re in both, scenario plan now just so you’re not caught flat-footed.
Andrew: Yeah, well, I’ll wrap this part of the conversation up here to say this is, I have said it many times, I think, on the pod and elsewhere, just another step on the path towards what I think is an increasing inevitability that some major company, Western company, likely a U.S. company, is put in a position where it is either in major contravention of U.S. law or of Chinese law. And what said company does in that situation and how the two governments react, and once that sort of situation inevitably comes to a head, is going to be, you know, I think really shape how these two legal systems, the clash of these two legal systems, ultimately plays out and how companies… It’ll set a precedent on kind of how companies ultimately have to react once they’re in that situation.
We’re not there yet, but I just feel we’re inching ever closer. I mean, the blocking rules basically are, they’re very explicit. The U.S. is saying, “You can’t do business with these companies,” and the Chinese rules are saying, “You can’t not do business with these companies.” We’re not quite there because, as you said, this is mostly aimed at Chinese entities. For the most part, Chinese banks are the biggest entities that are impacted or the most impacted entities. And they’re just trying to get some exemptions. And I’m sure the Chinese government will sort of work with them on that.
But once you get foreign companies in the mix, I think it’s going to be a disaster. But we will be here watching it all play out, analyzing it, helping companies to deal with it as well as this train just keeps rolling on. But in the meantime, Cory, I really appreciate you walking us through these latest developments. Very helpful. Thanks for being here today.
Cory: Hey, thanks so much for having me back. I appreciate it.
Andrew: Yeah, of course. And stick around, everybody, for my conversation on macro issues with Joe Peissel and Dinny McMahon coming up right now. Thanks!
I’m joined now by Trivium’s Head of Markets Research, Dinny McMahon, and Trivium’s Lead Macroeconomic Analyst, Joe Peissel. Dinny, how are you doing, man? Welcome back to the pod.
Dinny McMahon: Thanks, Andrew. Good to see you, mate.
Andrew: And Joe, welcome as well. Good to see you.
Joe Peissel: Yeah, cheers, Andrew. Happy to be here as always.
Andrew: Yeah, glad to have you guys back on. We are going to talk, as per usual, about the latest macroecon developments out of China. I just had a good conversation with Cory Combs about China’s economic lawfare movements or the most recent economic lawfare actions. So now we’re going to talk about macroecon. Just jumping into it, we’ll talk about the sort of Q1 economic data. We’re now into May.
This data came out in April, but still kind of gives us a good chance to get a read on where we are at this point in terms of China’s economic trajectory. So, the economy really got off to a pretty cracking start for the year. Much better, actually, than anyone was really expecting. Real GDP grew by 5%. Nominal GDP was 4.9%. And that’s actually the smallest gap between the two in three years, which is a consequence of producer prices finally turning positive after years of factory gate deflation.
So, this, of course, begs the question, how did China manage to do so well in spite of the Iran war? And why wasn’t the war or the impacts of the war showing up more in the data? And to the extent it did show up in the data, what are we seeing from that? So Joe, let me just throw to you. Tell us about Q1 growth and the, of course, the big thing hanging over every economy throughout the globe is the Iran war. So, talk to us a little bit about what you’re seeing from that, either positively or negatively in the Q1 data as well.
Joe: Sure. So, well, the short answer is the Iran war did show up in the data, but only in March. So, if you look at Q1 headline data, it looks pretty good, as you just said, Andrew, like decent growth, way above our expectations, a narrowing of the gap between real nominal growth. So, the GDP deflator is starting to bottom out. However, if you look just at March’s monthly data, that’s where the negative impacts of the conflict really show up.
Everything, and I mean everything across the board, slowed relative to growth that we saw in Jan and Feb — industrial output, investment, unemployment ticked up, rates of consumption declined even further. So yeah, again, if we look at the quarterly, the headline data, it kind of masks the impact of the Iran war a little bit, but that’s just by virtue of the Iran war happening in late Feb. So, it’s only shown up in the March data. I think the most obvious area it shows up, as you mentioned, is the price data. So producer prices, after more than three years of decline, I actually think it’s closer to three and a half years of decline, they finally moved into black.
They grew just 0.5% in March. And I mean, that’s significant less for the number. 0.5% growth isn’t much, but it’s significant because of the cause. This was imported cost push inflation, the worst type of inflation that policymakers can wish for. So generally, there’s two ways to inflate an economy. There’s a demand pool. This is where there’s so much aggregate demand that businesses, suppliers feel they can push up prices. Generally, that’s quite a healthy form of inflation because it means there’s a lot of economic activity. And then there’s cost push, which is because input prices go up.
So, manufacturers or suppliers are forced to raise prices. So, we saw that starting in March. We haven’t had any hard inflation data released for April yet. That will be next week. But there’s other metrics or proxies we can use. If we look at raw material prices, anecdotal survey evidence or PMI measures, this is firm-level survey data. This is all suggesting that we’re going to see an extension of these cost-push inflation into April, really across China’s industrial base. So, things like oil, fertilizers, plastics, chemicals, you name it. If it’s an industrial input, the odds are the price is going up.
Andrew: Thanks for that, Joe. Good explanation of kind of where we are. But kind of looking forward, would you say this is the end of deflationary pressures or is this more of a pickup in inflation in terms of cost pressures? I know that sort of seems like a splitting-hairs difference, but which one is overriding here? Is it the upshot of prices or is it really deflationary dynamics that are sort of petering out?
Joe: Yeah, so certainly it’s an uptick in long-term inflation, at least for half of the economy, which is China’s supply side. So, producer price deflation, that’s what I was talking about a few minutes ago about this, we had almost three and a half years of decline in producer prices. That was already starting to bottom out. And the Iran wars just accelerated that process. So, there’s now going to be a long period of rising producer prices, again, accelerated by the Iran war.
That’s one half of China’s economy. That’s the supply side. I think the big nuance or the question I’m looking at is, are we going to see that spill over into consumer prices? So, consumer price deflation, the decline in consumer prices, this actually ended about six months ago. And since then, consumer prices, CPI, has been growing very, very slowly, but it has been positive. Now, what I’m interested in is, are suppliers going to pass this cost per inflation on to consumers? I.e., are we going to see a huge spike in consumer inflation?
And from China’s macro perspective or China’s macro economy is really stuck between a rock and a hard place here. Because if manufacturers or suppliers more generally don’t do this, if they absorb this cost push inflation that they’re importing, mainly because of the Iran conflict. Well, that means they’re going to have a reduction in profits. And this has negative spillover effect on the broader economy, reduction in investment. Firms will scale back output. It’s going to impact the labor market. There’ll be an uptick in unemployment.
But on the flip side, if suppliers do pass these costs on, so we see this surge or this sharp increase in consumer price inflation, then that’s going to weigh on consumption, which is already really fragile. And it’s going to undermine real income growth, which again is already really fragile. So there’s no real good outcome from this. But in terms of understanding the trajectory for China’s macroeconomy in the coming months, it’s a really important question to be following.
Andrew: Yeah, well, you’ve written before, this was not the way that Chinese policymakers wanted deflation to end, right? This is sort of the, if you had to pick a way to end deflation, this is almost the worst possible way. Is that right?
Joe: Yeah, totally, totally. As I say, the economy is really between a rock and a hard place because there’s no good outcome from this cost-push inflation.
Andrew: Well, while we’re on the Iran war piece, the other big, there’s obviously the price impacts, but the other big impact was on exports. So exports rose more than 20% in January or February, then absolutely collapsed in March to only 2.5% year-over-year growth. Now, we have to warn, of course, that monthly export numbers are always pretty volatile. There’s a lot of seasonal factors that impact the numbers in any given month, you really can’t learn a lot about the fundamental state of China’s export regime. But tell us about the export numbers and how the Iran war is impacting this.
Joe: Yeah, so I think the general narrative is that the Iran wars massively undermine China’s export growth. I actually want to push back on this a little bit. I think there’s other factors at play unrelated to the Iran war that explain this huge drop in export growth. As you said, we went from, what, 20 plus percent to 2.5% in March – massive drop. But I don’t think this is really related to the Iran war. So, I think the first factor at play is base effects. So exports in March last year grew by double digits, they researched. And that was driven by exporters or buyers of Chinese goods trying to front load demand prior to the U.S. tariffs coming in.
So, we have this base effect impact, which artificially lowers export growth this year. And then beyond that, there’s also seasonal disruptions from the Chinese New Year. So, that happened in February, but it was longer and happened later than normal. And so, as a consequence, factories are still struggling to catch up with production. What’s quite interesting is that factory disruption, we see that most clearly in the manufacture of lower value goods, which rely more on migrant labor. And we know in China, it’s migrants who often are delayed return to factories during Chinese New Year because they travel back home to rural parts of China.
And we see that in the export data. Exports of low value ad manufactured goods. So think about things like toys, furniture, other cheap consumer durables — that’s really where growth declined the most. If we look at the export of higher value-add goods, anything like EVs or semiconductors or solar panels, growth was still pretty solid. I mean, that gives us a lot of evidence to suggest or tentative evidence to suggest it’s not really the Iran war that led to this sharp drop in export growth. It’s this combination of seasonal disruptions from Chinese New Year and base effects.
Now, in terms of what we expect from the Iran war, it’s actually very hard to conclude what the net impact would be at the moment. There’s clear downside risks. The main one being is the spike in oil prices erodes purchasing power or household incomes of some of China’s most important markets. So, the demand for Chinese consumer durables will decrease in places like Southeast Asia, South Asia, Africa, because these economies are so dependent on fuel imports. And so, the consumers there are most badly hit by the spike in oil prices. But I also think there are some upside risks to China’s exports, which haven’t really been talked about.
The first being Chinese manufacturers relative to the rest of the world are actually quite well shielded from the rise in energy prices because a lot of China’s energy is sourced domestically from coal. And that means that manufacturers, relative to foreign competitors, are actually going to become more competitive. And so that could potentially give them an edge in foreign markets. I think the second big upside, which no one again is really talking about, is that if this rise in oil prices is sustained over several months or longer, this is going to accelerate foreign governments’ demand or strategy to switch to cheaper forms of energy, renewable energy, solar panels and wind farms and all this sort of stuff, as well as electrify the grid and switch to electric vehicles.
All of these areas of, you can think of this as like clean energy or new energy industries, which Chinese exporters absolutely dominate. So some potential upside for specific sectors as well coming out of the Iran war.
Andrew: Yeah, great. Thanks for that. I think we’ve covered pretty well the sort of external dynamics, specifically the spillovers from the Iran war. I think, as you pointed out, it was really only in the March data where the export weakness started to show up and the trajectory, I think, arguably, as you made the case, is uncertain. We don’t know that ongoing tensions or ongoing war in the Middle East will undermine Chinese exports. And you made the case that actually there’s reasonable strength to be expected. Exports definitely supported the economy in Q1 in the first couple months of the year, leading to that sort of higher than expected overall GDP growth rate. I want to pivot now to the domestic part of the economy, the key parts of which, of course, are consumption and investment.
Dinny, I actually want to bring you in here because another big piece of the outperformance and growth first part of the year was this investment piece. And it seems in the midst of external uncertainty, weak consumption, that we’ll get into in a minute, authorities are really trying to front load some of the investment activity. Walk us through what’s going on on that side.
Dinny: Yeah, it’s interesting with investment because it’s not necessarily because of global uncertainty that we’ve seen kind of a ramping up of infrastructure investment. So firstly, the numbers. In the first quarter, China’s local governments issued about just shy of one trillion renminbi’s worth of special-purpose bonds that were earmarked for infrastructure investment. Now, that’s more than 17% higher than the first quarter last year. So, that in and of itself speaks volumes. I mean, that is a big increase in the amount of financial resources that local governments are deploying to infrastructure at the very beginning of the year.
The other thing going on is that, additionally, every year, the central government, as part of its ordinary budget, allocates a certain amount of money that will go into infrastructure, what it calls the two major projects. But anyway, it’s code for big, important, strategically important infrastructure projects. And the budget for this year is 800 billion RMB. And the economic planner, the NDRC, has already allocated, I think, 72%, 75% of those funds already. End of April is when they announced that. Now, by way of comparison, in the middle of May last year, the NDRC had said that they’d allocated 62% of the full year’s 800 billion RMB.
So, again, we’ve seen a real acceleration in the pace at which the state is allocating funds towards infrastructure. Now, of course, the question is, is this all about Iran? And seemingly, it’s not. You look at investment last year, and particularly in the second half of the year, and it’s slowed. I mean, infrastructure investment contracted, what, 2% last year. That’s mind-blowing. I mean, that does not happen in China. Infrastructure has been like one of the pillars of growth for years, it doesn’t go into reverse.
But last year, it was slower than the year before. Fixed asset investment in manufacturing slowed last year. Property was a bloodbath again. We wrote about this in February, I think. Beijing was just sending out constant signals that infrastructure is going to be important this year. And then the NPC happened. And usually, we get from the Two Sessions, we get some pretty clear signals as to how much money is going into infrastructure. But it was really blurred this year because of the infrastructure investment tools, special purpose bonds, special treasury bonds, so where the money was going from those bonds just isn’t as clear as it used to be four or five years ago.
So, we had the numbers of how much debt local governments and the central governments and the policy banks were going to raise. We didn’t really have a clear indication of how much of that would be going into infrastructure or would be going into activities that are explicitly stimulatory. All the signs were there. Beijing kept saying infrastructure is important, very important, but we just didn’t know. And now with these numbers about how much the local governments have actually issued what was earmarked for infrastructure, we’re like, “Okay, clearly this is a priority for the year.”
So, I think this would be happening regardless of global instability and what was happening in Iran. I think Beijing had already very much decided that we can’t see a repeat of 2025. We’ve got to ramp up infrastructure investment. Now, of course, this raises a bunch of questions because it feels like given the pace of the allocation and the issuance of these bonds is far faster this year than it was last year, what does it mean for the last quarter of the year? What does it mean for the second half of the year? Is it just going to peter out?
And I think at this point, we’re pretty used to Beijing reeling back around in, say, August, September, October, and saying, “Hey, guess what, everybody? We’re going to allocate a bunch of new funds that no one was expecting to infrastructure.” And I think it’s pretty clear we’ll see more of that towards the end of the year as well. But regardless of how much that is and when they announce it, I think it is pretty clear at this point that they’ve ramped up infrastructure investment. They see it as a big part of the economic mix this year, and it would be happening regardless of what was going on in the Middle East.
Andrew: Yeah, super helpful. So, infrastructure investment, strong, external environment, especially exports, uncertain with arguably some upside. What about on the domestic side of the economy consumption, Joe? What are you seeing on that front right now?
Joe: Pretty bad. That’s my answer. Shall we say more?
Andrew: Next.
Joe: Yeah. So, I mean, the consumption rotation in Q1 was really disappointing. I think retail sales of consumer goods grew by about 2.5%. Retail sales of services grew stronger. I think it was around 5% or slightly over 5%, which is a decent clip, but slowing. So, again, I talked about this earlier. We saw a slowdown across the board in March relative to January and February growth. That applies to consumption as well. And importantly, confidence dropped as well. So, the Stats Bureau has a consumer confidence index. They actually survey households about how confident they’re feeling.
And it’s been gradually improving over the past months. I mean, consumers on net are still pessimistic, but it’s been improving. And then in March, we’ve seen another sharp drop in consumer confidence. So, it’s all pretty dire news. I think, broadly, and this is maybe simplifying the framework a little bit, but there’s really three structural issues undermining China’s consumption. So the first is the property market, which we’ve talked about at length, but property prices are down at least 25%. So, that’s a quarter of household wealth just wiped out over the past few years. And then the second structural issue is there’s this absence of a robust, reliable social security system. And I mean that in the broadest sense.
So whether that’s universal healthcare or pensions or high minimum wages or help for those who are unemployed. And the third factor here, the third structural issue is slowing income growth. And that’s really pertinent because we saw that super clearly in the Q1 data. So, real household incomes per capita, disposable income growth grew 4% year on year in Q1. And that is way down from historical levels. Pre-COVID, so like pre-2019, household incomes were growing pretty consistently year on year around 6.5%. And since then, every year, it’s slowed. So in 2023, they grew about 6%; 2024, about 5%, so on and so forth. Until the first quarter of this year, they grew by 4%.
I mean, that’s over a third drop in income growth, right? And by the way, this is in real terms. So if we think about it in nominal terms, if we incorporate price effects, which is actually what’s landing in people’s pockets, right? So like the number on their payslip, growth has been cut way more because there’s been a slowdown in inflation as well. So inflation this quarter was about 1%. It’s actually 0.9%, but let’s say 1% roughly. So you take the 1% inflation plus the 4% real income growth, that’s about 5% nominal income growth this quarter, about 5%. If we look at nominal income growth pre-COVID, that was about 9.5%. So again, that’s real income growth plus inflation pre-COVID was about 9.5%. So, we’re going from 9.5% nominal income growth to about 5%.
That’s almost a 50% reduction. So, income growth has effectively been cut in half in about six years. It’s remarkable. It’s such a rapid decline in the rate that people’s disposable income is expanding. It’s kind of no wonder consumption is so low. And I think what makes, at least to me, what makes this figure really shocking, this effective cut, this 50% reduction in income growth, is that it’s at a time when the economy is supposed to be recovering. Like we’re seeing a decent GDP growth rate, we’re seeing a decent amount of industrial output and export growth. And that’s not translating into the numbers on consumers’ pay slips.
Andrew: Well, and you can see why that’s feeding into the sentiment numbers. If you only, six years ago, were expecting your wages to continue growing at a certain level, and now that your wages are growing at a half of that, I mean it just feels bad too. Not only do you have less money and you’re going to pull back, but just like your economic trajectory feels a lot more uncertain, right?
Dinny: Well, Andrew, if I can jump in here, I mean, this was always the story about when you were looking at young people buying homes in Shanghai and Beijing, right? Entry level, you were looking at paying something like 20 times your annual income, which is actually absolutely mind-blowing. Why would anybody buy a property at 20 times your annual income? But the reality was income growth was so rapid in China’s big cities that after five years, six years, seven years, the relative burden of paying, of servicing that mortgage plunged, not because the value of the mortgage had changed, but because what you were earning as an individual had just gone up exponentially. And so that’s the significance of expecting something between 8% and 10% annual income every year. It really impacts what the debt burden that you’ve taken on feels like.
Now, if all of a sudden, if you take on that mortgage and the expectation of like, my wages are going to keep going up like that, and all of a sudden they stop, then the relative burden of that debt that you’ve taken on, I mean, at the moment, not only is your house worth far less than you ever expect it to be worth. Secondly, the market value might be less than what you actually paid for it. And in addition to that, the burden of the mortgage is far greater at this point than you perhaps anticipated because your wages haven’t been going up.
Andrew: Yeah, totally. Totally. And again, those are real, not real as in real versus nominal, but like actual developments that impact your finances, but it also impacts your psyche. Just how you feel. I think how people feel about the economy, it’s become over the past few years very apparent to me how important that is both in the Chinese economy and the U.S. economy, where obviously I live. We’ve seen successive U.S. administrations kind of have a disconnect between what the official numbers around the economy say and their messaging around the economy versus what actual people care about and how far their dollar is going.
And that can have a real impact. And I’ve thought now for several years, basically, we’re in a similar situation in China, where people, even though the numbers, we just said Q1 GDP growth exceeded expectations and exports held up well and investment is humming, but people aren’t feeling it. So, I think that’s certainly a challenge for the Chinese leadership. I appreciate you guys walking me through all this. I just want to end up with kind of a little bit of a projection. We had a pretty solid Q1. What are you expecting, Joe, in the rest of the year, whether it be from the economic trajectory or from policy? I’ll pose that to both of you guys, then we’ll wrap up, but we’ll start with Joe.
Joe: So I think looking ahead, there’s a lot of certainties in China’s economic performance. We know the property sector will continue to decline. We know the industrial base will continue to grow. And we also know that consumption is going to underperform. I think what the big question mark is, and actually what’s going to be a really decisive factor for China’s economic performance is what happens to exports. And this relates back to what I said earlier, that there are clear downside risks from the Iran war, but I also think there’s upside risks that haven’t been talked about. Last year, China’s trade surplus accounted for about a third of China’s GDP growth.
So hypothetically, in a hypothetical world, if China hadn’t run a trade surplus, its economy would not have grown much faster than the U.S., for example. It’s not a very useful comparison because China did run a large trade surplus. But I’d make that comparison to demonstrate how important China’s trade is in terms of driving economic growth. Well, the same applies this year. So, looking ahead for me, I think as a business or as an investor, I think as a China watcher to understand what’s going to happen if China can hit its GDP growth numbers, what’s going to happen to the trajectory of the economy over sort of the medium term.
I’m talking like six to 12 months. It’s the exports, and it’s the trade surplus that are going to be decisive. Yeah.
Andrew: Yeah, that’s a good point. And I also will reiterate what I said last time you were on the pod when we had Jeremy Stevens on, and I was in Beijing, and that is simply that… I mean, that’s really the plan. Like, it seems like policymakers are saying to foreign officials and foreign companies, “It’s an export model, get used to it. We’re going to keep leaning on this. And we feel that our companies are just more competitive than yours. And we hear your complaints, but we don’t really care about them. And so that’s our path to nirvana and we’re going to stay on it.”
So. anyone out there who thinks they’re going to try to convince Chinese companies or Chinese officials to somehow dial back the export machine, just not happening. That’s the bet they’re placing. So, yeah, thanks for that, Joe. Dinny, your thoughts on what might be next?
Dinny: Yeah, well, I think they’ve built in a little bit of wiggle room with this year’s growth target. The fact that it was a range that they set it at 4.5 to 5%. And then Li Qiang said, “We’re going to,” you know, what was, I forget his exact wording, “but we’re going to try to do even better.” And I think if the Iran war hadn’t happened, looking at the first quarter, they would have been fairly confident about being able to do a little better. But with everything that’s going around, they’ve sort of built in a little bit of flexibility into their goals this year.
So, they can hit 4.5, which is a significant slowdown from last year, and they will still be within their range. They would have hit their target. Politically, everything’s cool. Yeah, look, I think what Joe said is incredibly insightful. I mean, you’d imagine that in this environment, global demand weakens, exports get hit, but China is in this really odd position where a lot of what, you know, it’s competitiveness and a lot of what it’s selling might actually see an increase in demand. But if that doesn’t eventuate, then at least Beijing is already shown itself willing to tolerate slower growth this year rather than last year.
Andrew: Yeah. Well, and I’ll just wrap up by saying, I think a lot of folks looked at China’s economy, in the wake of what was happening in Iran, and said, “China’s really vulnerable. And it turned out that they had done a lot of things to make their economy resilient to those external shocks.” And now everyone’s saying, “Oh, okay, China’s going to be the one who sort of can ride this out.” And so all that is to say, you know, anyone who’s thinking economic vulnerabilities are going to shape China’s geopolitical realities, I just don’t think it’s the case. I think they’ve created a lot of resiliency. And to that point, we’ve got an upcoming meeting with Donald Trump and Xi Jinping next week, which of course we’ll talk about probably on the pod two weeks from now.
But anyone who thinks that China’s domestic economic challenges are going to weaken its hand in negotiations with Trump, I think, are likewise have their analysis misplaced. But we’ll have a lot to talk about on that front in the next couple of weeks. We will be back revisiting all this, of course, as things develop. Guys, this has been really, really helpful really insightful. Joe, thanks a bunch for your thoughts today. I appreciate it.
Joe: Yeah, thanks, Andrew. It was good fun as always.
Andrew: Dinny, thank you as well, man.
Dinny: No worries, mate.
Andrew: And thanks for listening, everybody. We’ll see you next time. Bye.
