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John Norris (00:30):
Well, hello again everybody. This is John Norris at Trading Perspectives. As always, we have a good friend, Sam Clements. Sam, say, hello,
Sam Clement (00:36):
John. How are you doing,
John Norris (00:37):
Sam? I’m doing okay even with all the negative stuff that’s going on in the world right now. I’m doing okay.
Sam Clement (00:42):
Things could be much worse.
John Norris (00:44):
Things could be much worse. And this week here on Trading Perspectives, it’d be very tempted to talk about the recent assassination attempt on former President Trump. We could talk about sector rotation within the stock market as the markets just continue to go up and up and up. However, it’s not the tech stocks going up recently. It’s the stuff that hasn’t been going up for the last several years, finally getting its turned. It’d be easy to talk about that stuff, but we figured people can get that anywhere. So this week, Sam, I want to talk about the banking crisis in China and what that means for not only the Chinese economy, but also how Beijing is going to manage it and what that means for the rest of us.
Sam Clement (01:34):
Well, I think part of the reason, or really a main reason we kind of want to talk about this is that it’s kind of hard to find. You have to be looking for articles about this. It’s not the assassination attempt or the market the last week, two weeks. That’s kind of… in what we do that’s all that’s being talked about. And this is something that is frankly not being talked about. I mean, there’s some articles, but again, you have to look for it.
John Norris (01:56):
They’re not mainstream articles. They’re hard to find. It’s not on every television every night, but in case you really just didn’t know it. China’s residential real estate market has turned upside down and really kind of looks a lot like what things were starting to look like in 2008. At the beginning of 2008. They’ve already had some major property developers like Evergrande and others that have gone under, and this is an issue. It’s a huge issue because Chinese investors largely have always viewed real estate as their primary asset class. And so that is where a lot of retirees, that’s where a lot of people have sunk their money into new apartment buildings; saving up to get that house and out of the dorms or what have you, the communists had put up. So this was really a huge generator of wealth for the Chinese consumer for a lot of years, not unlike our housing crisis there leading up to 2008, but I’d say even more pronounced than that. And then all of a sudden the bubble has kind of been popped over there and no one’s talked about it in the West. And yet we’re seeing banks fail within the People’s Republic like nobody’s business and no one knows.
Sam Clement (03:14):
Well, this is kind of a culmination of several decades, and I think you have to go back to the Chinese now being allowed to own real estate. That’s kind of what started all of this. And it’s taken a while. It’s taken decades. It’s worked. It’s been growing. I mean, the economy …
John Norris (03:30):
It’s worked for people who buy one house, they buy another.
Sam Clement (03:33):
And so this multi-decade buildup in real estate is what’s causing a lot of this. And we’re seeing that it has a lot of similarities to the crisis that we had in the eighties with banks and the consolidation,
John Norris (03:48):
The same as the loan crisis
Sam Clement (03:51):
On kind of a probably soon-to-be bigger scale
John Norris (03:55):
Just by numbers alone that would have to be, because savings alone sort of separate and apart from the commercial banking over there. From what I can tell, there’s not a ton of difference. Now, don’t get me wrong, I don’t think this is going to lead to a collapse of the Chinese banking system because the money center banks in China are basically owned by Beijing. The Bank of China, whatnot, might be floated out there on some exchange somewhere. But various entities of the central government, various arms might own upwards of 65, 75, 80% of some of the largest banks. So obviously Beijing is not going default on itself. It’s not going to let itself go under. So I’m not worried about the money center banks, so I’m not worried about that level of liquidity. What I am worried about is 40 banks failed in China, and I think last week, no one here in the United States knew about it. This is going to have some kind of contagion, and what you’re going to see is borrowing and lending at the local level really dry up. And when that happens, it’s going to clearly stifle initiative on the ground level. And it’s also going to lead to a liquidity crisis for Chinese consumers.
Sam Clement (05:10):
And I mean, there was an article about this in The Economist talking about how some of these banks, these small banks that dot the whole countryside of China and have up to 40% of their loans are non-performing.
John Norris (05:23):
Yeah, well, that’s also known as out business.
Sam Clement (05:28):
And so if you see those numbers, it’s not a contained thing to a few banks, it’s this culmination of decades now of loans that have worked because the real estate just kept going up. And they may not have been good loans in the first place, but the fact that the market was doing fine, the economy was just exploding…
John Norris (05:52):
It’s almost a Ponzi scheme in that regard.
Sam Clement (05:54):
Yeah, it was hard to have non-performing loans.
John Norris (05:58):
It was hard to have non-performing loans. And Sam, when you get to a level of 40% non-performing loans, you might as well just call for the regulators because you’re not going to get your money back. You’re going out of business. And the thing is, for all those people that think otherwise, banks don’t want to take your real estate, they don’t want your collateral.
Sam Clement (06:16):
Right.
John Norris (06:17):
That’s the main core part of the banking business… because if a bank comes in and takes your collateral, that means you couldn’t sell your collateral to pay off the loan. So they don’t really want to take an underwater asset. They want you to pay off your loan. If you’ve got 40% non-performing, that’s just not 30 days past. That’s non-performing. You’re not getting that money back. Those banks are out of business. That liquidity that they used to provide has dried up, and you’re going to see the countryside really have some real issues. And then when small businesses and individual consumers don’t have access to credit or liquidity, then that really does kill small business creation. That doesn’t mean that Beijing can’t wallpaper over to a degree through the money center banks. And that’s kind of what I really wanted to get at here. As awful as what’s going on in the housing sector and the small banks sector in the Chinese economy, Beijing will be able to wallpaper over, to a little degree, just based on its overall control of the government. And Xi all of a sudden realizing the problems in the economy has decided to leak back into manufacturing again, heavy manufacturing in order to prop up exports, even as the domestic demand absolutely falls through the floor. So you’re having a very bifurcated economy right now. The headline numbers might say one thing – Chinese economy slip to 4% – it’s actually weaker for the average Chinese consumer, and it’s going to be a mess when they finally sort this out.
Sam Clement (07:54):
And when they sort it out, it’s going to be what, years?
John Norris (07:59):
It’s going to be years.
Sam Clement (08:00):
I mean a decade,
John Norris (08:02):
It’s going to be decades.
Sam Clement (08:03):
But the timing of all this, coincidence is not the right word, but it’s pretty bad timing with what’s going on globally. I mean, it’s horrible, the onshoring that countries are wanting to do the more national focus of a lot of countries, the diversifying of supply chain outside of China to some China plus one, but some Mexico, other countries, it’s very bad timing. I mean, we’re seeing prices fall. I mean actually come down in a lot of the data out of China.
John Norris (08:37):
And the thing is, what is kind of scary to me is: when people are having a hard time putting a chicken in every pot, when all of a sudden their household income is going down, they see their balance sheet erode. An old trick by governments being used for century is to rattle the saber and come up with an enemy, an outside enemy, in order to deflect or divert, deflect or divert attention away from the economic realities. You have to invent a problem. And that’s where I think we’re running into some issues that – what does Xi do in order to get people to quit thinking about how difficult the domestic economy is? Do they continue to have provocations with Taiwan? Do they continue to build reefs in the Spratley Islands pissing off the Philippines in the process? Do they get more aggressive in the sea of Japan? It’s like all of these things they can do and will likely continue to do and continue to build up the PLA and the PLA Navy. And the more that they build those up, that’s bad news for the United States.
Sam Clement (09:51):
Yeah, I think it’s worth noting that this is not a globally systemic issue. I mean, there’s leakage I guess in the other countries and industries and what have you. But the Chinese market is unique. The real estate investment exposure of the average person is much higher than other countries.
John Norris (10:20):
I would say even taking sort of a step to the side on this, I would say what makes this a little bit different than the US financial crisis in 2007 to 2009, technically 2008 to 2009, but that was foreign banks had far more counterparty risk with the banks that were in trouble here in the United States. Our money center banks were in trouble. Our large regionals were in trouble just due to how the housing market collapsed. So just due to interbank loans and what have you, that meant Deutsche had a lot of exposure that meant HSBC. It meant European banks, Asian banks, everyone had exposure. Everyone. Everyone. However, the thing about it is most, I would say, and I know I’m not completely accurate on this, but I would imagine and intuitively most of the counterparty risks that our major banks in the United States take with Chinese financial firms isn’t with the little $10 billion Bank.
(11:26):
I mean, that’s not who they’re taking their counterparty risk with. They’re taking their counterparty risk with the big guys, the super big guys, which aren’t going to fail because they’re owned by Beijing. So in a lot of ways, the rest of the world is a little more immune from the Chinese banking problem and financial crisis and housing bubble. And then also you have little things like capital controls by the Chinese and the way the financial system isn’t as integrated into the global economy as the US arguably is. So it’s not going to cause that level of discomfort as 2008 and 2009. Where it is going to cause discomfort is on the domestic scale. And really, I can fully imagine the Communist Party, the CCP Xi Jinping is going to use this as a wonderful opportunity to start gobbling up banks and propping them and throwing them underneath newly created public banks or banks run by the central government. And after that, they will be able to dictate how money flows in the economy much more strongly than they have over the last couple of decades.
Sam Clement (12:42):
Yeah, it’s kind of like there’s one less intermediary. There’s one less kind of step in the process.
John Norris (12:48):
This is a wonderful opportunity for the Communist Party to get rid of competition.
Sam Clement (12:52):
There’s not even a central bank. I mean there is, but it’s one in the same. I mean you could argue that ours is kind of overlapping as well, but at least there’s some kind of degree of separation.
John Norris (13:05):
Well, there’s at least the pretense of it.
Sam Clement (13:07):
Yeah. That’s not there at all. So the banks or the central bank or the government or Xi.
John Norris (13:15):
Yes. And the banks that are failing are the private banks. And I don’t think that Xi’s going to bemoan them or worry about them too much. He’s not going to miss them. And by the time the smoke settles and the dust clears or the, I got that wrong. Didn’t the dust settled and the smoke clears? You really will see a smaller private sector in the Chinese economy, and that is just fine with the communist party. And what we will likely see moving forward is gone are the days that China’s grown, eight, nine, 10%. One, they’re coming off of a higher base than they once were, but then two, you’re going to get back to far more centrally controlled, far more centrally planned and controlled economy. And just by nature, they’re not going to be as innovative outside of maybe the defense department.
(14:10):
They’re not going to be as innovative, and if they’re not as innovative, they’re not going to grow as rapidly. It’s also going to curtail foreign investment in China if the government comes in and nationalizes huge chunks of it and controls it and demands where the capital goes, foreign investors don’t want to see that. So I am truly looking for moving forward, depressed GDP growth rates out of the middle kingdom for the foreseeable future. And I’m also looking for, not looking for, but I’m anticipating the Communist Party is going to increase its power over the economy moving forward. Not that it hasn’t always had some, but it’s going to double down.
Sam Clement (14:52):
Where do you see this 10 years from now?
John Norris (14:55):
10 years from now I see this as China as never fully getting to that level that everyone thought they were going to. They never truly swamped the US economy. I see them with a larger military and a larger Navy, and dare I say it, they’re going to be the Asian equivalent of Russia, but larger. And they’re going to be a blunt force object out there at odds with what’s happening in the western world with the western democracies. However, they are not going to be that global hegemony that everyone thought that they were going to be in order to fully face off and compete against the United States.
Sam Clement (15:37):
I mean, the population growth is not continuing.
John Norris (15:42):
No, it’s shrinking.
Sam Clement (15:44):
So that tailwind of population boom, that’s hard to overcome no matter what policies you have. If you loosen up the ability to have investments at a time and real estate at a time where your population is exploding, that’s great. That’s not continuing.
John Norris (16:04):
That’s not continuing. Well, that’s what happened from the one child policy. You can’t replace your population with everyone who has one child. And so that’s what’s going on. And so I think the numbers start tailing off pretty quickly over the next several decades. China loses literally hundreds of millions of people. So they’re going to have to come up with the money to fund all these old people at the same time trying to grow their economy and be more efficient. But you’re just simply not going to be horribly dynamic and grow at an exponential rate. If the government controls everything. We’ve talked about it, that’s not an inclusive economy, that’s an exclusive economy. And ultimately politicians being what they are and as opposed to economists, they’re going to focus on things they can see, feel, and touch, and they’re going to focus on steel and other such things as opposed to technology. And those people’s brains and get up and go will get up and leave. They have, but they haven’t been. And we’re going to start seeing a huge surge or whatever you want to call it, of Chinese billionaires and entrepreneurs leaving that country if they can get their money out. And that’s the big “if.”
Sam Clement (17:22):
And that’s the thing with US investors as well, or just non-Chinese investors. I mean, there’s plenty already talking about how they can’t get their money out of the PRC. Why would you invest there or continue to invest there?
John Norris (17:38):
Sam, as you know, we don’t.
Sam Clement (17:41):
I know WE don’t, but you see people that are supposed to be really smart having money they can’t get out of the country.
John Norris (17:47):
I think a lot of people, when they buy into into China, they do so sort of indirectly or passively. If you were to ask the average American, do you really want to invest in the PRC? Hell no, I don’t. Do you want to have some emerging markets in your portfolio? Sure, why not? Yeah, yeah. That’s where the growth is.
Sam Clement (18:04):
Which is half the index, 40%.
John Norris (18:07):
Whereas I mean, you go take a look at some of the most, well-known exchange traded funds, VWO or EEM, and you’ll see a huge slug devoted to the People’s Republic of China. And it’s hard not to if
Sam Clement (18:20):
It’s hard not to if you’re just market weight.
John Norris (18:20):
Without a doubt. And we will always have some kind of indirect exposure to China just through supply chains and what have you. But it’s that direct exposure, which scares me. So, you and I have talked about this because of what’s been happening in China with its real estate market now with the banking crisis and increased focus back on the old tried and true heavy manufacturing and exports and increased focus on DOD spending, department of defense expenditures, I don’t think this is a very good bet. I don’t think they’re going to be focused on increasing profitability for the private sector. And if they’re not focused on that, they don’t care what happens to private foreign investors. And by the way, you buy into some of these Chinese companies, you’re not even guaranteed currently to get anything out of there. I can’t imagine what’s going to happen moving forward. I just think it’s a sucker spot.
Sam Clement (19:16):
Yeah. It’s like, look, we’ve seen some canaries in the coal mine out of Chinese private companies no longer talking about their earnings and their quarterly earnings reports. They’re talking about these government programs that they’re helping support. To me, that’s a very loud canary. I mean, picture Amazon or Apple,
John Norris (19:38):
I’m thinking of a bigger bird than a Canary
Sam Clement (19:40):
Picture, Amazon or Apple or companies of that size saying:Don’t worry about our earnings. We’re going to focus on this policy.
John Norris (19:48):
Yeah, the inflation reduction act. “Well, that’s what we’re going to focus on.” or “We’re going to focus on this as opposed to our profitability. ”
Sam Clement (19:55):
Years ago we first started talking about that, and the trend has only continued if not worsened.
John Norris (20:02):
Yes.
Sam Clement (20:03):
So that’s not a ship that turns very quickly, but it’s definitely turning away from the private sector.
John Norris (20:11):
It’s definitely turning away from the private sector. I think that ship will have completed its U-turn. You asked me where China is going to be in a decade. I think it will have completed that U-turn at that point. Doesn’t mean that it won’t be able to grow just as the Soviet Union was able to grow, but eventually the Soviet Union was trapped or had a ceiling by its own limitations. That’s the same thing that’s going to happen to China. I would tell you private investors out there, it’s not that there isn’t money to be made in China, but do so at your own risk. And I would say it’s not worth the risk personally. That’s not to say that we will never have direct Chinese investments at Oakworth Capital Bank, but when I take a look at it, I can’t imagine ever being overly bullish about the prospects of making money there.
Sam Clement (21:02):
I agree.
John Norris (21:05):
How about that? With everything going on in the world, we’re talking about investing in China and now we don’t like it.
Sam Clement (21:09):
Learn something new.
John Norris (21:10):
And this isn’t us being Americans or nationalistics. I mean, it’s just literally taking a look at things. I mean, so much wealth has been evaporated for the average Chinese consumer through this housing crisis, the banking issues that are going on. And then you just see Xi retrenching and trying to regain control over the economy. You add all this stuff up together. Go back to the three characteristics of any healthy economy, rule of law, which debatable, strong individual property rights. Real debatable. Real debatable. And then the development of human capital, which maybe they’ve got but two out of three aren’t there.
Sam Clement (21:55):
This isn’t baseball. One out of three is not great.
John Norris (21:58):
Yeah, one out of three is not great. So I just think there are other places where people can invest their money.
Sam Clement (22:04):
I agree.
John Norris (22:04):
Alright, well guys, thank you all so much for listening. We always love to hear from you all. So if you have any comments or questions, please by all means, let us know. You can always drop us at or you can leave us a review on the podcast outlet of your choice. If you’re interested in reading more or hearing more of what we have to say or how we think, you can always go to oakworth.com and go to the Thought Leadership tab and look for all kinds of exciting information, including links to previous Trading Perspectives, podcasts, links to our blog / newsletter Common Cents, and links to our quarterly analytical piece, which we call Macro Market, which is getting ready to be released, I think probably any day now. So be looking for that. Alright, with that, Samuel, I’ll give you last chance to say something good on this topic.
Sam Clement (22:54):
That’s all I’ve got.
John Norris (22:55):
That’s all I’ve got today too. Y’all take care.