China Crashes as Investors Jump Ship | Chinese Economy | US-China: AI Race

China sees surging market pessimism as sovereign bonds crash, PBoC's unprecedented move, & the US-China AI race heats up

China Update provides listeners with the most up to date political, economic, and geostrategic analysis on China - so that you are on top of the world's number 2 economy.   These podcasts are based on hundreds of articles, think tank reports, government statements and other resources in English and Chinese every week. The views and analysis are all my own and I produce the podcasts. 
My Patreon: https://www.patreon.com/chinaupdate 
 
Disclaimer: China Update is not a financial advisory channel. While I take great care in researching everything discussed in these podcasts, nothing I say should be taken as investment advice. Please speak to a professional before making any investment decisions. #China

Episode Transcript

Speaker 1 (00:00):
Heppey Saturday. Everybody, Welcome to another episode of China Update,
where it provides you with the most up to date political, economic,
and geostrategic analysis on the world's number two economy. My
name is Tony. Let's jump in and we have some
fairly incredible news to cover in today's episode, which will
largely be focused on the Chinese economy. China's eleven trillion
US dollar government bond market is showing unprecedented signs of

(00:22):
pessimism as this week, yields on ten year sovereign bonds
plummeted to record lows, creating a three hundred basis point
gap with the US counterparts. China's economy faces sluggish growth
and chronically low inflation. Regular viewers know this, of course, startly,
contrasting global trends of rising interest rates due to inflationary pressures.
Long term interest rates in China have plummeted to record

(00:45):
lows as investors increasingly shun riskier assets like stocks and
real estate in favor of bonds, a sign of deep
pessimism in the economy for the foreseeable future. The decline
underscores deep concerns over China's economy potentially sliding into a
deflationary spiral akin to Japan's lost decades of the nineteen
nineties and two thousands, with one Hong Kong bond trader

(01:08):
dramatically expressing this week that this is it. China is done.
While this may prove to be a little over the top,
the situation is pretty bad. Despite recent stimulus measures, including
efforts by Bejing policymakers to spur domestic demand, evistas remain
wary of whether China can avoid prolonged economic stagnation. The
tenure bond yield recently dipped below one point six percent

(01:30):
for the first time, falling far below levels seen during
the two thousand and eight global financial crisis and the
COVID nineteen pandemic. Richard Ku, chief economist at Namoro Research Institute,
speaking to US based Bloomberg this week, observed quote, if
the bond market is right, the implications would be profound.
He described the situation as a quote balance sheet recession

(01:53):
end quote where both households and firms simultaneously prioritize debt
reduction over spending, stifling economic growth. The similarities between China's
current predicament and Japan's deflationary struggles are striking. Both countries
experienced a real estate crash, weak private investment, tempered consumption,
and an ageing population. Investors are increasingly looking to Japan's

(02:14):
experience for insights. Although Beijing has rolled out stimulus measures
and declared its determination to stabilize the currency, analysts argue
that these actions are insufficient. We consumer confidence, an unresolved
property crisis, and a lack of robust policy measures are
suppressing inflation and fueling feares of long term stagnation. Some

(02:34):
experts remain cautiously optimistic, noting that China's situation differs from Japan's.
Huang Yingrei of AXA Investment Managers, for example, suggests the
country is experiencing a quote partial balance sheet recession end
quote mitigated by the government's spending power. Notice, though even
this optimistic outlook admits that there is a partial balance

(02:55):
sheet recession. Others highlight emerging industries such as electric vehicles,
which could help China transition away from its debt driven
growth model. However, as we've explored in previous episodes, some
economists and analysts have pushed back heavily against this argument,
and still the clock is ticking. Data show's China's GDP deflator,
the broadest measure of economy wide prices, is at its
longest deflationary streak the century. Meanwhile, consumer and producer prices

(03:19):
continue to have a near zero Indeed, it could be
much worse, as US based Rhodium Group recently noted in
a report we covered a few days ago. Quote economists
associated with China Finance Forty Forum, a think tank, recently
argued that consumer Price Index CPI growth over the past
three years was around negative two percent, well below official figures.

(03:40):
Analysts warn that delayed action could worsen the crisis. Sinyaoying
of ABRDN PLC told clients in a note this week,
quote It's a downward spiral that will keep getting worse
if it is not corrected. Moving to the next development. Then,
on Friday, in a striking sign of the Chinese economy's stagnation,

(04:02):
the Central Banks said that it had temporarily stopped buying
government bonds. Central Bank's unexpected action is aimed at breaking
a recent shift by investors toward purchasing bonds, which have
driven China's long term interest rates to a record low.
This is quite the move and is a huge red flag.
It marks a departure from typical monetary policy responses. During

(04:23):
periods of economic weakness, Chinese households, wary of plunging housing
prices and volatile stock markets, have channeled unprecedented amounts of
money into low interest savings deposits with banks. However, commercial banks,
unable to lend these deposits effectively amid week business confidence,
have resorted to investing in bonds. People's Make of China's
paws and bond purchases aims to tamper this trend, prevents

(04:47):
a potential bond bubble, and stabilize the market. This decision
is notable given that central banks typically by bonds during
economic downturns to inject liquidity into the market. For example,
during the two thousand and eight financial prices, the US
US Federal Reserve employed this strategy extensively. The People's Bank
of China itself recently pledged to maintain a quote moderately
loose monetary policy end quote to support growth. We covered

(05:10):
this at the time, but we also warned that the
monetary policy was already incredibly loose and that something like
this may actually happen This abrupt shift has puzzled some observers,
including Mark All of Harvard, who today called it a
mixed signal. However, Peaking University professor of finance Michael Pettis
explained in an observation yesterday that this should have been foreseeable, explaining, quote,

(05:34):
China does not need more stimulus nor even more monetary
easing to boost inflation and raise bond prices, nor is
that what the bond markets are saying. On the contrary,
a quick glance at the debt numbers shows that China
has plenty of both, and rather than raise prices, years
of more fiscal stimulus and greater monetary easing have in

(05:55):
fact accommodated a weakening consumption's share of GDP bigger than
ever trade surplus and disinflation. That's because, contrary to the
implicit assumptions of most analysts, the Chinese monetary and fiscal
systems do not operate like those in the US or
the EU. While the US and the EU, fiscal and
monetary expansion tends to be directed to the demand side

(06:16):
of the economy, in China, like in Japan in the
nineteen eighties and nineteen nineties, it is almost wholly directed
to the supply side of the economy. More fiscal stimulus
and monetary easing, in other words, will not raise the
domestic demands share of GDP, nor will they raise inflation
and bond yields. In fact, they may just make matters worse.
What China needs is not even more of the same,

(06:39):
but rather a transformation of the way fiscal stimulus and
monetary easing is directed into the economy. That is much
easier said than done, of course, but until it happens,
very little will change. The move from the People's Bank
of China yesterday also aims to stabilize the currency, which
is depreciated against the dollar due to interest rate differentials,

(07:02):
encouraging currency outflows. Now, despite these efforts, yesterday, China's stock
markets reacted negatively, with major indexes declining further. The CSI
three hundred, for example, is down five percent year to date.
Now I often get complaints that this channel focuses too
much on negative stories and as such isn't balanced. However,

(07:23):
I reject this argument. The poor state of the economy
is the story at the moment and will likely continue
to be in the coming months at least, and yes
We can touch on bright spots like ev production and
export numbers, and we will, but the fact of the
matter is, at the moment at least, China's economy is
in a very dire state, and that is the story

(07:44):
that we need to follow. I would rather be accurate
while appearing unbalanced than are pairing balanced while being inaccurate. Now,
before I move to the final part of today's episode,
I wanted to share something personal with you all. For
those who are not interested, you can jump to part
three of the video. It should be on the timeline below.
Click that and you'll be able to skipple of this.
But for everyone else, I just wanted to share a

(08:05):
couple of things. Regular viewers will know that I almost
never share personal things about myself with you. You're here
to learn about China and to try and understand China,
not to hear about my life. But it's the weekend
and it's a special day, so I hope you will
forgive this indulgence on this occasion. Today is my birthday,
and on my birthday, I normally like to look back

(08:27):
at the year, reflect on the year ahead, and also
take the opportunity to reflect on what I'm grateful for
I'm grateful for many things, and one of the things
I realize today is I am deeply grateful that I
can work on this channel every day. It is something
I really enjoy doing, and to be able to do
this and share it with you all as a tremendous
pleasure for which I am deeply grateful. The channel has

(08:50):
grown rapidly in the last few weeks, and it does
look like in the coming weeks or perhaps this month,
the channel will hit one hundred thousand subscribers. Of this
channel almost five years ago as a hobby that I
want to share, and I thought if it could git
to one hundred subscribers that that would be pretty amazing.
The idea that I could soon be at one hundred

(09:11):
thousand subscribers is something that I am still getting to
grips with. Regular viewers will know that in the last
month or so, I've moved to a format where the
title and thumbnails are a little bit more provocative. I
was very hesitant to make this transition the YouTube platform
unfortunately demands it, but it does seem like it has
meant that this channel has been shown to many new viewers.

(09:34):
In fact, there are viewers now probably watching this that
have only joined in the last few days. This is
probably only due to the YouTube algorithm reacting to the
high click through rates and showing these to new people.
While it's regrettable that on this platform, creators have to
do this, as I've said before, no matter what happens,
the videos themselves will continue to remain grounded and sober.
As I've said in the past, if I get to

(09:55):
one hundred thousand subscribers, I think this would be safe
enough for me to move to doing this channel full time.
This means that it looks like this year twenty twenty
five will be the year when this happens. The idea
that I will be able to do as my full
time job, something that I really enjoy, that I really love,
and that I can share it with so many of
you is a dream come true. So long story short,

(10:18):
On my birthday today, I want to express to you
the China Update audience, both long term regular viewers as
well as newer viewers who may have joined in the
last few weeks. Thank you. Thank you for supporting me
over this time. Thank you for allowing me to do
this channel every day. Thank you for allowing me, perhaps

(10:38):
this year to do this as my main job. Thank
you for joining me on this journey to understand this
consequential and complex nation. Thank you. Now let's continue with
today's video. Next up, we move to the ongoing US
China technology war, and specifically the AI race. US based
Bloomberg reports that the US will imminently announce and quote

(11:02):
expansion of semiconductor trade restrictions to most of the world.
The regulations would create three tiers of chip curbs. At
the top level, a small number of US allies would
maintain essentially unmitigated access for American chips. A group of adversaries, meanwhile,
would be effectively blocked from importing the semiconductors, and the
vast majority of the world would face limits on the

(11:24):
total computing power that can go to one country. The
third most restrictive tier affects China, Macau, and all countries
for which the US maintains an arms embargo end quote.
As of the writing of this video, these rules have
not been released, but they may be out by the
time this video has been uploaded. Otherwise, according to the article,

(11:44):
at least they will come out in the next few days.
Beijing obviously is not happy with this development. However, US
big business isn't too pleased either, as US based Wall
Street Journal rights this week quote tensions between national security
hawks and the biggest American technology companies over policy has
burst out into the open. The globs come off this
week because of anticipation that the Commerce Department would immediately

(12:08):
introduce a global export license regime for graphics processing units,
the type of chip critical to AI applications, and set
sales caps for certain countries. The goal would be to
close off loopholes that otherwise could allow China to access
AI chips by tapping data centers in regions such as

(12:28):
Southeast Asia and the Middle East. Quote Oracle Executive vice
president Ken Gluck in a blog post, called the new
rules quote the mother of all regulations quote, adding that
it quote does more to achieve extreme regulatory overreach than
protect US interests. Quote. Even before the public clash this week,

(12:48):
tensions had bubbled beneath the surface. Weeks after the first
round of US export controls, Nvidia released new chips for
the Chinese market that were modified so that they didn't
require a US export license. A year later, the US
updated its controls and Nvidia updated its China chips so
that they again would avoid the export ban. In December
of twenty twenty three, Common Secretary Gina Ramando expressed frustration

(13:11):
at dealing with what she described as industry resistance to
export controls, expressing quote, they're in the business of making money.
Every time I take an action, it denies them revenue.
We have to have our eyes wide open about the
threat from China and work together end quote. Meanwhile, some
US analysts argue that China is advancing in AI despite

(13:31):
US chip restrictions. In November of twenty twenty four, Ali
Barber and Chinese AI developer deep Seek released reasoning models
that by some measures, rival open AI's one preview. The
same month, Chinese video game Juggernaut ten Cent, which was
recently labeled by the Pentagon as having military connections, unveiled

(13:51):
Hunyan Large, an open source model that the company's testing
found outperformed top open source models developed in the United
States across sever benchmarks. Then, in the final days of
twenty twenty four, Deep Seek released deepsek V three, which
now ranks highest among open source AI on a popular
online leader board and holds its own against top performing

(14:14):
closed systems from open AI and Anthropic then aart m,
a lead on AI and computes at the RAND Corporations
Technology and Security Policy Center, experienced this week. Quote we
had a year where China could just buy chips which
are basically as good as the most advanced ones end quote.

(14:34):
He explained that loopholes and US export restrictions in the past,
coupled with the time for new chips to find their
way into AI developers' infrastructure, is why quote we are
yet to see the export controls have a full impact
on China's AI development end quote. Meanwhile, Japan based financial
media outlet nicqu Asia reports this week that China is

(14:54):
gaining on the US in AI research, with Singhai University
in Beijing chase Google. Quote. Of the fifty institutions with
the most accepted papers last year, forty seven hundred and
sixty six authors hailed from the United States, more than
any other country. China came in second with eight thousand,
four hundred and ninety one, with an eightfold surge over
the past four years. Six of the top ten institutions

(15:17):
are based in the US, including Google, which ranked first,
Stanford University, Microsoft, and Meta, while Chinese players rounded out
the list. Tinghwai University ranked second and Peaking University came
in sixth. End quote. Meanwhile, while we're on this theme
of US technology curbs. In recent days, US Commerce Secretary
Ramundo told UK based waiters that the final rules for

(15:37):
connected vehicles targeting China will be done next week, just
before the Biden administration leaps office, expressing to the outlet quote,
it's really important because we don't want two million Chinese
cars on the road and then realize we have a
threat end quote. In September, the Department proposed prohibiting key
Chinese software and hardware and connected vehicles on American roads

(15:59):
due to national security concerns. That move would effectively bar
Chinese cars and trucks from the US market. Major global
automakers would have to remove key Chinese software and hardware
from these vehicles sold in the US and the years ahead.
The White House cleared the final rule last Tuesday, according
to a government website. Veteran China analysts built Bishop observed
on this development yesterday. Quote. The hacking and the malware

(16:22):
in key US infrastructure helped garner support inside the US
government for these rules. Okay, that is today's episode of
China update. Thank you so much everybody for watching. Have
a good Saturday, have a RESTful weekend, and I will
see you all on Monday. We covered this at the time,

(16:42):
but we also warned that there was only so much
co