16/11/2013 Talking Business with Linda Yueh

suspicion of murder. No odd BBC News it is time for

talking business. `` now on BBC News.

Welcome to Hong Kong. Debt is the new normal for people in China.

Since the crash, companies, banks and even household have borrowed at

unprecedented levels. The big question is, is China headed for a

debt crisis? Joining me today for a special

debate to discuss whether China is facing a debt crisis are the

chairman of the movie capital group and the former chairman of Goldman

Sachs in China, also advises the Chinese government on financial

reform. The chief financial economist who for `` who once worked

at the financial authority and warns that the debt crisis is very real.

Jim models, one of the most respected investors in the world who

has declared that Asia is the place to be in the future. Welcome to all

of you. Fred, I will start with you. Everyone thinks of China as a nation

of savers, but we have also seen estimates of private and public debt

rating something like 200% of GDP. What has caused this increase? There

has been a rapid build`up in the overall level of debt in China.

China was not really the episode of the global financial crisis but the

magnitudes, the size, China responded overwhelmingly so clearly

China is one of the most indebted economies in the world. But to put

into perspective, even at that level, China is still below

Australia and South Korea. Jen, do you agree? You have warned that the

rising debt is dangerous. As Fed said, China's current debt level is

still lower than those levels of the other economies and is higher than

most of the emerging market. Not only is the level very high for the

judge percent, but also the rapid pace of this level is build`up over

the past five years, it has risen I think by estimates by 70% of GDP

since 2008 two 2012. This place is much faster than the pace that we

had heading into the financial crisis and higher than the US before

2007. Gym, where do you, this? I hear there is a rapid build`up of

debt and as a function of the list of government spending in Britain

after the global crisis, so maybe you `` maybe there is not much

concern but in Jen's view the pace is worrisome. I am not sure anyone

really knows. China is a gigantic country and I am not sure anyone

knows. Yes there was a rapid... Debt because of the conditions which fed

and Jian talked about, but China has huge assets. They are the largest

order of foreign currency reserves in the world, unless someone is

lying, and they have a huge savings rate. The save and invest over 35%

of the income. Other nations like the United States sees 2% of their

income to the Chinese have huge reserves backing up whatever debt

there is. The government in Beijing and know they have a debt problem

with too much acceleration of debt and are trying to do something about

it. I wish in the United States they were trying to do something about

it. They are increasing debt. In the United States today they say the

solution to too much debt is more debt. Grown`ups say things like that

out loud. I would rather be in China with the creditors than in the US

with the debtors. Jian, can the government to do something about

this? I am not looking for an imminent debt crisis, and partly for

the reasons Jim has mentioned that the Chinese government still holds a

large middle assets. Even local government has a lot of land at

their disposal. But such a level of debt in the pace of the build`up is

very concerning and as we discovered particularly this year, despite the

rapid rise in H, economic growth has continued to slow and this

diminishing return on investment is also a source of concern. Jian,

let's say we have bankruptcies in China, I think that's how capitalism

works. That is the economics is supposed to work. People got

overextended and go bankrupt, cultured people come in and we start

over. You are right, but the problem though is that there is no default,

no bankruptcy has been around. This is my poll `` this is my proposal to

regulators, we must allow default thing and bankruptcy to happen

because there are significant moral issues. It is not just China, in the

west we don't let people go bankrupt either, or in Europe. Fred, let me

bring you in. Where do you stand on this? Is the possibility of removing

these hazards, the idea that the state can still guarantee all of the

debt, can that be addressed in an effective way? Hazard is real and

risk and the underlying cost is state ownership. And also local

governments. Somebody is going to clean up your mess. The new

leadership, they really need to focus on the fundamental. To reform.

Jian, I want to back`up a local governments debt, because clearly

this is an area, you see this as the key source of worries about

continuing debt build`up veteran Mark we have written in a report in

the past year that local governments debt not only opposed the biggest

fiscal risk but especially combined with less rapid growing of the

shadow banking system it also causes significant financial risk. What is

to my comfort is that the Chinese government, despite a lot of market

economists and people arguing, it is not a big concern, the Chinese

government are actually concerned about it. The president highlighted

local governments debt and overcapacity. Help us understand

the, why is local governments debt such a worry? If central government

can do something about it, why is it still continuing to build up and

oppose this risk? We need to go back a little bit to why we get to where

we are, in 2010 the National audit office announced that the local

governments debt level is 10.7 trillion, close to 30% of GDP and

many people believe that number is probably underestimated. I think one

reason for this is because the local government, the chance of promotion

is highly related to GDP growth so they will be very enthusiastic to

grow and develop. The current fiscal system in China actually leads to a

mismatch between the revenue source for local government and also the

expenditure responsibility which is one of the reasons the local

government must rely heavily on revenues in the previous years, when

the property market was booming. In the past two years they have

resorted to trust financing and also the end ERC observed a lot of local

governor debt. It sounds to me that one of the problems is the fiscal

system in China is not rationally structured. Local governments are

responsible for a lot of spending, they do not get allocated a lot of

revenue. They are limited in terms of borrowing because there isn't it

fully fledged immiscible bond market and therefore the end of doing

things which rely on banks and create off balance sheet stuff. We

have learned terms like trust companies. Does this sound too good?

This is the way you rising countries work. In America in the 19th`century

we had 15 depressions, as recently as 1907, the whole system collapsed

because everyone was running around doing crazy things. America was a

huge debtor nation. China is a huge creditor nation and it has been

spending a lot of money but much of it has been going into productive

capacity, whether it is highways or schools or whatever, I am sure some

of it has been wasted but in the West they are borrowing money for

nonproductive assets. So let's see China collapses, let's say China has

a recession, at least they look about other side with more

productive assets in contrast to Greece, Portugal, the United

States, where they will come out with more bureaucrats. Jim has

brought a crucial point. This is where financial innovation can fuel

the industrial relation in England and in North America and now in

China. When the money is used efficiently and productively,

projects that will generate a deterrent. There was excessive rapid

tool box of debt and I suspect and I believe that state`owned enterprise

borrowing and the in the local government borrows might have been

down to not only inefficient but donate whistle projects. You will be

called any position of not being to service the debt. Jian I want to

bring you in. What estimate have you been looking at? In terms of whether

or not there has been bad step in the system. Isn't contributing to a

property bubble? We can always look at the glass half full or half empty

and I can see Jim clearly look at the glass half`full and at least

half of the productive investment but for me, I come down on the other

side on this. The least conservative estimates are 20 to 30% of the local

government debt, bubbly running the risk of turning bad or turning

unproductive. I am also a supporter for infrastructure investment. If it

is any good area. For example I always like to use the example of

high`speed rail between Beijing and Shanghai. It is clearly includes the

consumption around the region and travel and tourism and business.

Shanghai is a great example. But at the places there. Chinese people

can't actually afford to buy homes there. Is there a bubble in the big

cities? How was it impacting normal people? Since 2009 we have been

talking about the property bubble in China, there is less of a consensus

and agreement but in the past few years if you go to China even

anecdotally you can see in many places there is oversupply of

properties. That is a waste of resources. Like Fred mentioned,

Chinese people are hard`working. We have huge savings. But they get

negative interest rates with them so Chinese people spend their money

domestically in the property and they have lowered the borrowing

costs. These have supported, I think, a lot of the waste and

brought forward spending of local government and banks. Jim, you have

a view on how China can address this? One of the things they can do

is make the currency compatible. This money is trapped in China so

they do not have any choice. Other than to buy more property. The

bubble will eventually pop and the crisis will come down. Some people

will lose a lot of money and we can start over. But also, if they make

the currency convertible, it will make a more normal flow of capital

and then people can do other things. You just mentioned is the

bubble bursting. Two lots of people who went through the sub`prime

crisis that sends ominous. Why? It is the way the world works. People

get overextended and some people lose money. That is opportunity for

others. You are Chinese, you must know the term gain and yang. I'm

sure my pronunciation is abysmal. `` yin. Crisis is opportunity. Some

people suffer, other people will benefit. That is how the world

works. I know what happened in the US and that was an insane situation

with hopeless regulation. You cannot buy five or six houses in China with

no job and no down payment. That is what people in America were doing,

so it is an entirely different situation. It does not mean that

some people will not suffer. But don't worry. I'm not worried. I

think the Chinese government's tolerance for property price

correction is probably at 20 or 30% at most. Property prices have

continued to increase over the past year, Spike the government holding a

firm stance on the market. On the property sector, I think the

government's policy has been trying to balance between containing the

rapid property price increase, and avoiding a sharp deceleration in

investment. Because that is very important. And if you ask me, that

is where they are making a mistake. They should let the chips fall where

they may. You are right, they keep letting the prices go higher. They

say we have a problem and they do nothing about it. They need to be

tough and crackdown. There is a few things here that I'd want to hear

your views on, things that are beginning to worry me. The property

bubble, if it exists, 20 or 30% deceleration is quite a lot. The

sub`prime crisis, maybe that is something that China will face or

maybe not. But shadow banking, we have not spoken about that, the

unregulated lending in the system not captured by the official balance

sheets. This and the property bubble, is that a recipe for

disaster? I would argue that shadow banking, for all its faults, it has

played a useful function in economic development, in spreading credit

more equitably across people and firms who would otherwise have been

denied access to capital. But I worry that there are issues of

disclosure and mis`selling. There is going to be corruption, no question.

Hopefully there will be more people going to jail accountability.

Gigantic growth, and not much good to me, that is part of the system.

The differences, in the US that was essentially no regulation. The red

letters did not know what they were doing and they were totally over

their heads. Secondly, there was a massive amount of leveraged which

cannot take place in China. You cannot buy a lot of houses. You can

borrow too much and you can go to the shadow banks, but if you borrow

money, maybe you will go to the casino. But most of the money that

is borrowed in China is not going into crazy housing bubbles and

things that are not so productive. I want to bring you in on this. To me,

this sounds reassuring. We do not have to eat too much of a shadow

banks, because of the state dominated banking system. Consumers

and small businesses have to go somewhere for financing. If

something goes down, somebody will come in and rescue at? Is that about

right? What is concerning is the rapid growth of shadow banking. I

think a few years ago, if we use the broad definition to include trust

and acceptance of private lending, it was less than 20% of the GDP. But

by today, it could well reach 40% of GDP. That itself is probably came if

the economy can continue to grow at 15% on a nominal basis. But we know

that the Chinese economy, in my view, the potential economic growth

rate has already lowered from 10% to 7%. I'm not seeing any imminent

financial crisis. Even the banks have 20% reserve required in law.

That can be used to ease any financial stress. Can get you on

this? Lots of people have been watching what happens to the rate at

which banks lend to each other. It is now shot up in two double

digits. `` into. Was that just a botched attempt to try to crack down

on shadow banking? Not at all. It was an accidental credit mistake on

the half of Japan. It should not have happened. I'd guarantee that it

will not happen again. Whatever banks do, loans, to the private

sector or whoever, they are funded by a deposit liability. It is not

relying on wholesale funding. This risk is really remote. I would like

for Fred to be right. But I'm afraid there will be a crisis in China. In

America, we had 15 depressions as we rose, and we still became the most

successful country of the 20th century. China is better regulated

and better managed than America was in the 19th century, but the Chinese

are not perfect. We have 300 million people with a huge amount of money.

Somebody is making a mistake and somebody's going to suffer. Crisis

is human nature. Every economy if you look at the history of humans,

we see so many, like Jim mentioned, so many crises during the business

cycle. But I worry about two things. One is deposit insurance. Will

people lose their shirts? Will back is a huge problem if the banks fail?

And secondly, given the thing you have said, about bad loans and not

knowing how much is going to rise, can China afford to rescue the

banks? Which banks will fail? Crisis? Crisis means opportunity for

a smart investor. The Chinese government has a huge was

possibility on their shoulder. It has 1.3 billion people, many of them

living on less than $2 a day. Social stability and enhanced economic

stability is very important for China and also, not only for China

domestically, but globally, international communities are

demanding China to be responsible. That means that Chinese growth needs

to be capped at a stable base. So it does not drag down the global

economy. The Chinese government is in a difficult situation. They

cannot just do what they would like to do to clean up access, to restart

the system to put the country into a more balanced situation. Have to

take gradual steps and that is difficult. `` they have to take.

That is a good point trust to do a summation. Why will try this and

bear with me because it is going to have to be yes or no in the interest

of time. `` I will try this. If I was good to ask each of you, if we

are going to have a financial crisis, will it drag the rest of the

world down with it? Will it have a global impact? You have got it

backwards. The crisis will come from the West and the developed world,

which will affect China. China is one tenth the size of the American,

European and Japanese economy, no matter what it does write to the

rest of the world is going to have an effect. It is going to cause

problems in China. But I would rather be with the creditors than

the debtors any day. I think the Chinese government will do

everything they can to try to prevent a financial crisis or a debt

crisis or the burst of the property bubble from happening. But they are

walking a fine line and the chances of friction could be very high. So

that is a yes? And it will have a global impact? Clearly. Fred, the

final word for you. What is happening in China will have a

meaningful impact on the rest of the world. We're close trading

partners. But I think with new leadership committed to fundamental

structural reform Tom I believe China has a good chance of

containing its problems, dealing with them, and making a meaningful

and revision to global growth. On that note, that is it for this

week's debate. `` meaningful contribution. We have had an

interesting discussion about the drivers and causes of the debt

worries in China. It is fair to say that the panel is hopeful that the

Chinese government is on top of the situation. But I've fear that if

China sneezes, the rest of the world may just catch a little bit of a

cold. My thanks to my panel, and thank you all for watching. Join me

next week for more. Good evening. 15 degrees today in

north`eastern Scotland. But it was predominantly cloudy and cool for

the rest of us. Cold is featuring quite predominantly over the next

few days. We have cloud sat across us at the moment, that is this

weather system here, and that is