Zhang Ming | Stagflation under triple pressure and China's economy in 2024

Note: This article is a transcript of the author's speech at the Caijing Magazine's annual summit on November 22, 2023, and has been reviewed by the author. Please be sure to indicate the source for reprinting.

Distinguished ladies and gentlemen, good morning. I am very happy to participate in this Caijing Annual Meeting, and I am also very happy to see the annual meeting return to offline and return to China World Hotel.

I will make a 15-minute statement today, and I will focus on two issues: first, the world economy will remain in a stagflationary pattern in the next few years, which is shaped by triple pressures, and second, what is the impact of the current external environment on China's economy. Here I would like to present two judgments about 2024. One is that from a balance-of-payments perspective, we may face a situation where the current account is under pressure and the financial account is improving. The second is that China's foreign exchange and stock markets may be passing an inflection point.

Whether next year is the so-called "mediocre year" of Mr. Zhu Min or the plate differentiation pointed out by Mr. Li Daokui, from the perspective of the macro situation, the stagflation pattern formed from 2022 will continue. Stagflation is a combination of low economic growth and high inflation, such as 3.5% and 7%-8% inflation in 2022. The formation of the stagflation pattern is mainly due to the triple pressure.

The first pressure is the intensification of geopolitical conflicts. First, the Russia-Ukraine conflict has been going on for almost two years, and it has not ended so far, and we don't know when it will end. Second, once the Palestinian-Israeli conflict expands, it may involve some major powers in the Middle East, such as Iran and Saudi Arabia. Third, although there have been recent signs of marginal easing in Sino-US bilateral relations, the general direction of the long-term and sustained nature of the Sino-US game will not change.

The impact of geopolitical conflicts on the world economy is mainly channeled through two channels. First, commodity prices typically rise significantly in times of heightened geopolitical conflicts, which can exacerbate global stagflationary pressures. Second, geopolitical conflicts can affect investor sentiment. When conflicts intensify, investors increase volatility in financial markets by adding to safe-haven assets and reducing risky assets.

The second pressure is the strong cycle of the US dollar. There are two main reasons for the high inflation in the United States since 2021, one is the supply-side shock caused by the new crown epidemic, and the other is that the US government has implemented an unprecedented and extremely loose fiscal and monetary policy after the epidemic, especially fiscal policy, which has raised the temporary income of low- and middle-income households. After a year and a half of raising interest rates and shrinking the balance sheet, inflation in the United States has fallen to around 3-4%, with core inflation slightly higher than nominal inflation. But it will be a bit difficult for the US core inflation rate to continue to fall in the coming period. Why? Because the U.S. labor market is still tight, which will put upward pressure on wages and wages, so the prices of services and rents in the CPI basket will not fall. So while the Fed may not raise rates again, the chances of a rate cut in the first half of next year are low.

In other words, the world will remain at very high short- and long-term interest rates for the next six months, which has two implications. One implication is that there may be new financial turmoil. In fact, since the Fed raised interest rates in March last year, we have seen two waves of financial turmoil. The first wave was the outbreak of financial crises in nearly 10 emerging markets or developing countries due to short-term capital outflows, such as Sri Lanka, Pakistan, Lebanon, Turkey, Egypt, Zambia, Ghana, Argentina, etc. The second wave was the banking crisis in Europe and the United States in the second quarter of this year, and one of the reasons was also because of the Fed's very steep interest rate hikes. What are the possible risk points in the future? First, the US high-yield bond market, and the other is the US real estate market. The second implication is that the downward pressure on the U.S. economy will be greater in the coming period.

The third pressure is the impact of the new crown epidemic on the global industrial and supply chains. Although the epidemic has passed, after the outbreak of the new crown epidemic, many developed countries are rethinking the past supply chain chain strategy. They used to focus on efficiency, but now they are looking for resilience. In the United States, there are two terms "nearshoring" and "friendly shoring", that is, the overseas business of multinational companies should be outsourced to countries that are geographically close enough to them or countries with good bilateral relations. As a result, the global industrial chain and supply chain have formed a new trend of regionalization, localization and fragmentation.

There are two main potential impacts of the fragmentation of the global industrial chain and supply chain. First, it will reduce the efficiency of global allocation of resources, push up the production cost of various commodities, and slowly push up the global inflation center. Second, it will weaken China's position as a core hub in the global industrial and supply chains.

Together, these three pressures shape the stagflation pattern. Where does stagnation come from? A strong dollar cycle will lead to a downturn in global economic growth, and geopolitical conflicts will also affect economic growth. Geopolitical conflicts have led to an increase in commodity prices, and the fragmentation of industrial and supply chains will lead to a decline in the efficiency of cross-border allocation of resources and an increase in production costs. The global economy in 2023 is undoubtedly a stagflationary pattern, and it will be basically the same in 2024. How long this stagflation will continue will depend on the direction of geopolitical conflicts and whether we can find new ways to reshape global growth in the future.

What will China's economy look like in 2024? Personally, I am mainly engaged in international financial research, so I would like to analyze it from the following two perspectives. First, China will continue to be under pressure on the current account, while the financial account will improve. Second, the current domestic stock market and exchange rate are at a short-term inflection point.

On the one hand, the current account, represented by trade in goods and services, is likely to remain under pressure in 2024. There are two main levels of stress. On the export side, the global economic downturn caused by high interest rates will weaken global demand, and in addition, the import restrictions imposed by the United States on the mainland will challenge our exports to developed countries. On the import side, first, with the marginal improvement in bilateral relations between China and the United States, we have re-increased imports of U.S. agricultural products (such as soybeans), and second, rising commodity prices have increased the cost of imports for the mainland, which is highly dependent on its imports. Therefore, a further decline in the mainland's trade surplus in 2024 may be a high probability event.

On the other hand, there may be an improvement in the mainland's financial account in 2024. In terms of direct investment, this year we have experienced a significant decline in FDI inflows, something that has not happened for many years. However, given that multinationals do not have a lot to go to, other host countries have their own problems, and that China's economic growth is rebounding and our institutional environment is improving, FDI inflows are likely to improve significantly in 2024. In terms of short-term capital flows, short-term capital is likely to shift from large outflows to inflows next year.

I wrote an article 10 days ago titled The short-term inflection point for China's foreign exchange market and stock market may be coming. Why do we have this judgment? In the past, we have communicated with many domestic and foreign fund managers. The question we ask is, why have we introduced so many favorable policies, but investors' expectations in the stock market and foreign exchange market have not reversed? Their answer is that they have three core concerns: First, judging from the high-frequency data, has China's macroeconomic growth really bottomed out; second, has the liquidity dilemma of private developers in China's real estate market been truly alleviated; and third, has there been any marginal improvement in Sino-US bilateral relations? In recent times, the answers to the above three questions have become clearer.

First, judging from high-frequency macro data, the bottom of China's economy this year is July. During the three consecutive months of August, September and October, most of the data rebounded, such as the growth rate of consumption and the growth rate of profits of industrial enterprises. Of course, we should also note that the data on investment, exports and M1 are still not very good. Some time ago, we issued a new 1 trillion yuan of national bonds, of which 500 billion yuan will be used this year and 500 billion yuan will be used next year. Treasury bond issuance raised the fiscal deficit to 3.8% of GDP this year from 3.0%. This move sends a signal that fiscal policy next year is likely to be more accommodative than this year, which is very important to stabilize market players' expectations for economic growth next year.

Second, after the launch of the Central Financial Work Conference at the end of October, there are two important meetings that deserve our attention. First, Shenzhen SASAC participated in Vanke's third-quarter results conference. There were two key messages at the meeting, one was that the chairman of Shenzhen Metro said that we had never considered reducing our holdings of Vanke shares, and the other was that the director of Shenzhen State-owned Assets Supervision and Administration Commission said that Vanke had long been our reporting company. I believe that after this meeting, Vanke's liquidity dilemma will be fundamentally improved. Second, the central bank, the State Financial Regulatory Bureau, the China Securities Regulatory Commission and the Ministry of Housing and Urban-Rural Development jointly convened a meeting to which many private and state-owned developers were invited. Personally, I believe that the above two meetings represent the beginning of the Chinese government's efforts to address the liquidity difficulties of private developers in the real estate market. As long as the Chinese government intervenes in a timely manner, concerns that private developers may go bankrupt en masse will be dispelled.

Third, there has been a significant marginal improvement in China-US relations recently. In the past six months, there have been more and more high-level visits between China and the United States. Especially after President Xi's recent visit to the United States, you can see that China-US relations are moving in a positive direction in the short term. There is a lot of talk about how many areas may reopen in the future.

To sum up, the three core issues that are most important to domestic and foreign institutional investors are improving. In light of this, I believe that the stock market and the foreign exchange market are approaching a short-term inflection point. Judging from the performance of the past week, the view on the inflection point of the foreign exchange market has been verified by the market. Therefore, we expect better performance of Chinese equities in 2024.

That's all I have to say, thank you!