An economist experts pessimistic on China's economy

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On November 24, well-known Chinese economist Fu Peng delivered a speech titled "2024 Year-End Review and 2025 Outlook - Hedging Risks VS Soft Landing" at an internal event of Shanghai HSBC.

The following is the summary, about 2500 words

Fu Peng compared the operating mechanism of the world economy to a pyramid structure, with ideology at the top, politics in the middle, and markets and assets at the bottom. He believes that since 2016, the world has begun to shift from the left-wing inclusiveness, openness and integration of the past 40 years to right-winginging, conservatism and confrontation. This is not just manifested in the US-China trade war, but in a profound shift in the global political and economic order. This shift marks the disintegration of the globalized order that emerged after World War II.

Regarding China's economy, Fu Peng pointed out that the problems have been apparent as early as 2019 and are far more serious than what is seen on the surface. The core problem lies in the lack of effective demand, and judging from the data, the aggregate demand curve has continued to fall after 2019, going negative for the first time in 22 years by October 2024, the first time in 22 years. This lack of demand has both cyclical and structural causes, the most important of which is the accelerating fall of the middle class.

In the field of consumption, Fu Peng observed a clear trend of differentiation. The bottom class has long since begun to downgrade its consumption, such as online car drivers who only eat 15 yuan boxed lunches. The middle class has panicked because of layoffs and pay cuts, and has begun to drastically reduce spending. This decline in spending power is not a short-term phenomenon, but a structural shift. More importantly, the consumption concepts of the new generation of young people have fundamentally changed.

For the real estate market, Fu Peng believes that the rise in the past 20 years was built on two foundations: the demographic dividend and the amplification of leverage. the post-80s generation was able to utilize the wealth of three generations at the same time: the savings of the previous generation, their own paychecks, and the future credit offered by financial institutions. However, this model is now unsustainable because the young people's ability to take over is severely lacking.

Fu Peng particularly emphasized the nature of the debt problem. He believes that the statement that “domestic debt is not debt” is wrong, and that any country's local currency debt is essentially a taxing right on its own residents. When the population is not growing and income growth is slowing, the only option is to raise taxes. This explains why various recent discussions on new taxes have emerged.

In terms of industrial policy, Fu Peng puts forward the “JQK” theory: J stands for entry, Q stands for captivity, and K stands for open competition. He believes that China's industrial development cycle has been compressed to about 5 years, much faster than the usual international cycle of 30 years. During the period of government protection, firms are generally able to make a profit, but once the period of protection is over, they quickly fall into excessive competition and survival of the fittest.

Regarding the Japanese economy, Fu Peng provides a unique perspective. He believes that the essence of Japan's problem is not economic growth, but distribution. The key to Japan's emergence from 35 years of economic stagnation lies in intergenerational distribution: as the older generation begins to pass away, the younger generation will naturally get a bigger slice of the pie. But he warned against simple analogies between the Chinese and Japanese economies, but rather to look at different sectors separately.

Fu Peng's interpretation of economic data is also unusual. Instead of looking at the CPI, he looks at inflation figures net of food and energy to judge demand, as food price fluctuations often have little to do with real demand. He also pays special attention to the youth unemployment rate, but points out that changes in the caliber of statistics can affect the true meaning of the data.

On supply-side reform, Fu Peng traces it back to the Zhu Rongji era in 1997. He sees 2002 as an important starting point, when the PPI turned positive, core CPI turned positive, and effective demand turned positive. This benign situation lasted until 2012, when supply began to oversupply, and 2009 saw a double-dip in supply and demand, marking the beginning of the end of the cycle.

For urbanization and infrastructure investment, Fu Peng proposed to look at indirect tax revenue rather than direct revenue. He believes that the real returns of infrastructure projects such as high-speed rail come from supporting land appreciation and real estate development, but this model will be unsustainable after the demographic dividend fades.

Fu Peng particularly emphasized the characteristics of the new generation of young people. Their consumption concepts are completely different from the previous generation, they pay more attention to value for money and are willing to rent luxury goods instead of buying them. Their way of socializing and entertainment has also changed fundamentally, and they are not interested in traditional investment products such as stamps at all.

In terms of the financial market, Fu Peng believes that the market will go through three stages: policy guidance, market competition, and survival of the fittest. He warns against the “winner-takes-all” theory, which could lead to industry-wide difficulties when demand shrinks. He also paid special attention to the relationship between volatility and leverage, that this year's U.S. stock market, “high valuation, low volatility, high returns,” anomalous combination of next year is difficult to sustain.

For enterprise competition, Fu Peng proposed to pay special attention to the “far ahead” of the signal word. When the PPI turns negative, it means that the industry has entered the stage of vicious competition. He suggested that enterprises should prepare for future vicious competition in the policy support period, because overcapacity will inevitably lead to a decline in profit margins across the industry.

At the level of national strategy, Fu Peng points out that industrial policy brought about by right-wingingization has an obvious statist tendency. The goal of certain industries is not to make profits but to “have”, i.e. to ensure the existence of the industry. Such a policy would concentrate resources to achieve the goal in the short term, but it would also bring structural problems at a later stage.

Finally, Fu Peng provided insights into the wealth effect. He believes that purely rising asset prices cannot sustainably create a wealth effect, and that rising asset prices without income support will eventually return. Wealth accumulation of the younger generation is facing unprecedented difficulties, and the wealth distribution of the whole society is undergoing structural changes.

He also analyzed the opportunities in emerging markets, arguing that attention should be paid to opportunities similar to China's early stages of development. However, he also warned that the labor cost advantage is changing and the increasing awareness of young people's rights is also affecting the investment environment. At the same time, special attention should be paid to the opportunities brought by the imperfect financial system.

In the exchange rate and monetary policy, Fu Peng believes that China is facing the “impossible triangle” dilemma, the need to find a balance between interest rates, exchange rates, capital flows. The current exchange rate range of 7-7.3 matches the existing policy, but the future policy space is constrained by multiple factors. Such constraints will affect the effectiveness of China's economic policies and the space for choices.

Fu Peng's view on globalization and trade is unique. He believes that the current “long US, short Canada” trading strategy reflects a right-wing trend. Canada's over-admission of immigrants has resulted in the cake of economic growth being shared by too many people, which inevitably leads to a conservative and anti-immigrant tendency among the public. This situation is common in developed countries, such as the United Kingdom has also shifted from anti-Chinese to anti-Muslim, reflecting the global characteristics of right-winging.

On investment strategy, Fu Peng put forward the insightful theory of “polarization”. He suggested that investors should either be the richest or the poorest, as the middle market is disappearing. Taking luxury goods as an example, he suggests only buying Hermes, while brands like Chanel and LV will be squeezed. At the other end of the spectrum is the extreme value-for-money market, such as the second-hand luxury goods rental business that has begun to flourish in Hangzhou.

In terms of inflation analysis, Fu Peng uses a unique analytical framework. Instead of looking at the overall CPI data, he pays special attention to core inflation net of food and energy. He believes that this better reflects the actual consumer demand, because the matter of food always needs to be resolved, and other consumption to reflect the real economic situation. This view is rarely mentioned in current economic analysis.

Fu Peng describes an interesting phenomenon regarding the operating mechanism of the capital market. He believes that China's capital market is often the worst time in the economy, the government's most active, the emergence of “the worse the economy, the better the stock market,” the anomalous phenomenon. The essence of this phenomenon is the strong intervention of the policy on the market, but this intervention itself also reflects the actual situation of the economy.

When analyzing the problem of young people's employment, Fu Peng put forward profound insights. He believes that the expansion of master's degree enrollment ratio (1:3, i.e., 5,000 undergraduate, 15,000 master's degree) in top universities such as Qing and Beijng is actually slowing down the employment pressure. This not only reflects the harsh reality of the job market, but also implies that the education system is tilting toward graduate education.

Regarding the digital economy, Fu Peng particularly mentioned the employment shift brought about by the platform economy. Where did the tens of millions of new online taxi drivers come from in the past few years? He argues that they come in large part from the meteoric rise of the middle class, rather than from what is traditionally thought of as a shift in rural labor. This observation reveals the profound changes that are taking place in China's employment structure.

As for enterprise management, Fu Peng put forward the deep logic behind “cost reduction and efficiency”. He observed that this year's wave of layoffs from financial institutions actually reflects the systematic decline of the middle class. When this group begins to feel the pain, the entire consumer system will undergo a fundamental change. This change is not cyclical, but structural.

When talking about the real estate market, Fu Peng put forward the concept of “exchange time value”. He believes that when a person buys a house with 2 million dollars and sells it to a young person with 6 million dollars, he is actually taking away the current cash discount of the young person's youth in the next 40 years. This analogy vividly illustrates the intergenerational wealth transfer effect of the real estate market.

As for the internationalization strategy, Fu Peng believes that China is facing a situation similar to but different from that of Japan in the 90's. Japan could solve its domestic problems through the appreciation of the yen and overseas expansion. Japan was able to solve its domestic problems by appreciating the yen and expanding overseas, but the international environment that China now faces has changed fundamentally. This makes it unfeasible to simply copy Japan's experience.

Regarding consumption upgrading, Fu Peng particularly mentioned the change of young people's consumption concepts. He used his daughter's example to illustrate that the new generation is no longer pursuing traditional luxury goods, but is more concerned about new categories such as “pain bags”. This reflects the generational change in consumer culture, and traditional brands need to rethink how to attract young consumers.

Fu Peng gave a very unique explanation on the relationship between ideology and economy. He used marriage as an analogy, arguing that women are inherently right-wing, as in “I'm not right, it's all your fault”. For a family to be harmonious, men need to take a left-wing position. This analogy was used to explain the global economy: when the world is left-wing, there will be inclusiveness, openness and common development; when the world is right-wing, it will inevitably lead to confrontation and conflict.

Regarding supply-side reform, Fu Peng provided a complete historical lineage. He pointed out that the supply-side reform in 2006 can actually be traced back to 1997 under Premier Zhu Rongji. The starting point for all of this round in China was 2002, when the PPI was positive, the core CPI was positive, and effective demand was positive, which lasted until 2012. Supply started to go into overdrive, but effective demand could continue to be leveraged. 2009 saw a double-dip in supply and demand, which was the end of this big cycle in China that started in 2012.

Fu Peng describes a complete cycle of financial markets: when the economy is at its worst, this hand (policy) will be the most active, with an inverse relationship; in the middle, it will surely revert back to being related to the economy; and then it goes that way, with an administrative relationship when it gets too exuberant. This cycle explains why the Chinese stock market often moves in the opposite direction of economic fundamentals.

Fu Peng particularly emphasized the misunderstanding of Buffett's investment approach. He pointed out that many people misunderstand Warren Buffett's large cash holdings as a bearish approach to the market, when in fact the “cash” is in stocks with zero volatility and a 4.5% dividend. This asset allocation strategy reflects management of volatility rather than a judgment of market direction. This view shows his deep understanding of the essence of asset management.

Regarding the new global economic landscape, Fu Peng believes that the United States is undergoing a reconfiguration, and the new Trump administration is more right-wing than in 2016. This time, all those coming up are from the Establishment, reflecting the fact that right-winginging has been completely unchecked. He predicts that this battle will be even harder than the one in 2016, meaning that the global economy may face greater uncertainty .

Finally, Fu Peng's policy advice for China's economy is to “hedge” rather than “solve” because the current issue of effective demand involves a combination of short- and long-term factors. He believes that we can not stimulate the economy by increasing leverage, but to reduce leverage by reducing the stock of mortgage interest rates and other ways to let the bank spit out money to the people can pay 800-1000 yuan less per month. This reflects his pragmatic thinking on macroeconomic policies.

I feel one more addition to further slow China's economy is a Trump's administration threat of trade tariffs towards China. He has threatened a 10% tariff on all goods coming from China. I hope cooler heads prevail and realize such an action might cause a possible trade war( I feel if he does raise tariffs again China will probably place an equal tariff on all American goods entering China). I hope Xi Jinping and Trump don't get involved in a game of economic chicken