«China will not be able to De-Dollarize under Xi Jinping»

George Magnus, the former chief economist of UBS Investment Bank and author of the book «Red Flags», explains the disappointing economic recovery in China and says why the talk of de-dollarization remains wishful thinking.

Mark Dittli

Deutsche Version

China is turning into a disappointment for global financial markets. The hoped-for boom following the end of the zero Covid policy has fizzled out. Consumers are holding back, and the real estate sector in China is not getting off the ground.

In an in-depth conversation with The Market NZZ, the economist and longtime China observer George Magnus talks about the political and economic challenges facing the world’s second-largest economy. He warns investors from placing too much hope in monetary and fiscal stimulus measures: «That might give a sugar rush to the stock market, but not much more.»

«China’s sustainable rate of growth is probably no more than 2 or 3%»: George Magnus.

«China’s sustainable rate of growth is probably no more than 2 or 3%»: George Magnus.

In early 2023, investors had high hopes of a recovery boom in China. It has turned out to be a disappointment. What happened?

The government has been quite vocal that they wanted to see a consumption led recovery. Many economists thought it was almost inevitable that there would be a consumption rebound as people had become very restrained in their spending in 2022 because of the lockdowns under the zero Covid policy. What’s happened is that although we’ve seen a bit of a rebound in low-ticket items such as eating out and travel, we haven’t seen a robust recovery in home sales, automobile sales and more expensive things. There was much greater caution by households than we thought was likely based on what we’d seen in other countries that had left Covid behind.

Is there a crisis of confidence among consumers?

We may still see a delayed rebound in consumer confidence and sales in bigger ticket items. We shouldn’t rule it out just yet. But the clock is ticking, and there is a possibility that it won’t happen.

Why would that be?

Part of it is a psychological thing, and part of it is a structural problem. The psychological issue is caused by what’s been going on in real estate during the past two plus years, about homes that have been promised that haven’t been delivered. China has a pre-sale model of home sales, which means you start paying your mortgage even before the property is built or finished. A lot of households have been affected by this. Given the fact that so much household wealth is tied up in housing, people have become very cautious. They have built up their savings deposits in banks, and so far they haven’t wanted to liquidate them.

And the structural problem?

This predates Covid. It’s the familiar story that in China, because of the unbalanced nature of its economy, household incomes are a low part of the economy, and consumer spending is only about 40% of GDP. They don’t account for nearly as high a proportion as in other emerging market peers, let alone in the US, Europe and East Asia. That’s the structural issue which the government has not wanted to deal with for years. So we’re looking at a double whammy, a structural constraint and a psychological problem which both affect consumers’ willingness to spend.

On the issue of the disappointing recovery, markets hope for new monetary and fiscal stimulus measures. Would that jumpstart the economy?

It might give a sugar rush to the stock market, but not much more. The problem with monetary policy is that interest rates in China are already very low. To think about monetary policy easing further, it’s very similar to the kind of discussions that we had in the West after the Global Financial Crisis, about whether an ever more expansive monetary policy would spur credit demand. The answer is it didn’t. It just created a lot of liquidity, but it didn’t revitalize the dynamism of private sector spending. I don’t think cutting interest rates in China would have that effect either.

And fiscal policy?

Here we would be talking about bond issuance and funding for projects like infrastructure. This has been tried year after year for the last twenty odd years. China has gotten itself into a situation where a lot of that money is uncommercial, it has ended up just piling up debt for local governments. If the answer to low economic growth was just to build more things, then China wouldn’t have an economic problem. But obviously projects such as the construction of bridges or airports have to be commercially viable, otherwise they just become a deadweight to the economy. I don’t think the central government is keen to releverage the economy in terms of allowing local governments to spend more money for infrastructure. Having said that, if the consumer doesn’t come back soon, the government might be tempted to weaken its resolve and sanction the approval of new infrastructure spending.

Because it would be the easiest thing to do?

It’s the tested and easiest fallback solution. What the government should really do is have a meaningful internal debate about how to strengthen the household sector. That could involve distributing state assets to the private sector, increasing social spending or the central government taking on the liabilities of local governments. But to do that would mean that the corporate side of China’s economy, which includes state-owned enterprises and local governments, has to pay a price. That’s a political decision rather than an economic decision. I don’t think that’s one the Party leadership is prepared to take.

The property market, which is around 20 to even 25% of GDP, seems to be unable to gain traction. What’s the problem there?

In a nutshell, it’s the result of a long term housing boom. The property market in China has seen minor cyclical downturns before, but it has never really had a shakeout. It was continuously propped up and expanded to the point where it’s become laden with debt and excess capacity. It's possible that the property market is just going to mark time for the next five to seven years, because there is such a vast amount of overconstruction. This is not necessarily a problem in Tier 1 cities like Shanghai or Shenzhen, but it is a huge problem in smaller Tier 3 or 4 cities. This is where about 60 to 75% of the housing stock and most of the excess inventory is located. No markets go up forever. Eventually, overly high prices and high inventories combine to bring about a problem. There is also a huge demographic challenge, given that the cohort of first-time buyers, who are typically aged between 25 and 40, is going to fall by about a quarter over the next 15 to 25 years.

So no hopes for a revitalization of the property sector?

No. We are talking about a sector that is already too big, and that has no future in which it’s got any real basis on which to re-expand. So it’s just got to shrink, period.

The Party leadership has talked about a rebalancing of the economy and strengthening the consumer sector for years. Why is that so hard?

A large part of the answer arises from the economic philosophy of the CCP. It does not believe in the welfare state as we know it in Western Europe. It’s very much focused on what it calls supply side structural reform, which is really about the community benefiting from the uplift in economic growth which arises from allowing companies to produce more. The Party has a strong focus on production, but not a big focus on consumption. Xi Jinping’s China has this view that if they can fine-tune the production side, that this will lift employment and incomes throughout the economy.

That sounds like the dream of every supply-side economist. Doesn’t it work?

I don’t think so. Since the Party has started talking about an unbalanced economy, which goes back to 2007, nothing really happened. It’s been 16 years, and the consumption share of GDP is hardly higher than it was back then. So, they put too much emphasis on production and investment, not enough emphasis on consumer welfare and social security. Consistent with the structural weakness of the economy, inflation in China is lower than elsewhere because there is plenty of supply, but not enough demand. That imbalance between the consumer side and the investment side holds back the potential for the Chinese economy. But mind you, this is a Western economist’s point of view. It is not a view that many Chinese economists would share.

So the property market will not be a driver of growth, investment neither, consumption is not coming along, and exports are in a slump. This looks rather bleak, doesn’t it?

Yes. We’ve all developed our careers in the last twenty or so years being accustomed to either double digit economic growth in China or something close to that. But in fact growth in China has been halving each decade recently. We had growth of roughly 10% to 12% per annum during the 2000s, then about 5 to 6% in the 2010s, and I think in the 2020s China’s sustainable rate of growth is probably no more than 2 or 3%. That stepwise halving in each decade is a reality, you can’t argue that it’s some freak factor. There is obviously something going on in terms of sources of sustainable growth. So I think China’s policy makers will have to choose between either good 2 to 3% growth or bad growth. The good growth would come from a rebalancing of the economy, if they were finally to do something about household income and consumption. Bad growth would be if they tried to fuel it just by building more infrastructure and real estate.

Xi has projected for 2035 for China to be a moderately wealthy society. If we are talking 2 to 3% growth, won’t China risk getting stuck in the middle income trap?

There is a realistic prospect that China won’t realize the lofty objectives that the Party has set out for 2035 and also for the Centennial of the founding of the People’s Republic, which states that China aims to be the dominant economy and power by 2049. I don’t think those plans are really on track at the moment. As for the middle-income trap, the big threat is that the ability of private firms to be genuinely innovative and independent is restricted by Xi Jinping’s desire for control. This sacrifices long-term economic potential.

Yet at the same time, Chinese companies repeatedly manage to surprise, the latest example being their progress in electric vehicles. How does that go together?

It’s true, we see China’s success in dominating areas such as the EV market, to the point where people say that Germany’s car industry could be in serious danger. There is no question that China has a very skilled workforce in nominally private companies and that they can accomplish great things.


Remember how we were all in awe about Japanese companies like Sony in the 1980s? They were world leaders in their fields. But that didn’t prevent Japan from running into a major macroeconomic shock which has taken it a long time to recover from. That's the parallel I see here. They need to get on top of the debt situation. We know that there are other issues, such as demographics. There’s a certain inevitability about aging societies, but I’ve always had a problem with the mantra that demographics are destiny. There are coping mechanisms that China could implement to offset the negative consequences of aging. But managing the debt burden away, and creating a rebalanced economy which would strengthen household income and consumption, and at the same time revitalize productivity growth – these things require totally different kinds of policies which aren’t really on the agenda as far as one can see. So yes, my view is that China has a much more pedestrian economic outlook ahead. It will still achieve significant progress, but the cost of disposing of the consequences of overindebtedness will be felt in terms of weaker growth and higher unemployment.

The legitimacy of the Party is partly based on its ability to create jobs and to allow prosperity to rise. Is that entire process now in danger, leaving several hundred million people in rural China in poverty?

The question is at least relevant now in ways in which it wasn’t before. The legitimacy of the CCP does depend importantly on the ability to deliver rising aspirations of wellbeing for citizens. We had an interesting window into that during the protests that emerged during 2022, as people in lockdown communities started to express themselves. We also had instances of labor unrest, protests about unpaid wages, poor health and safety conditions, lots of things that go largely unreported outside of China. You could see that there is a state of disquiet among younger people and among workers. That is worth keeping an eye on.

After the 20th Party Congress in October, many observers, including you, said that Xi had surrounded himself with yes men. Is that still your assessment today?

I don’t think there is any question that the people who rose to the top positions in the Party and government leadership structure wouldn’t be there if they weren’t avowed supporters of Xi. In that sense, yes, they are yes men. But that doesn’t mean to say they are incompetent or technocratically incapable of governing. They are very competent. What it does mean is that if the leader, Xi, makes poor political judgments – in all matters, whether economy or foreign policy or society –, then there won’t be any kind of questioning or critique anymore. And that’s not good either. Again, it’s a difference in perception. We in the West think that it is good to question leadership in ways which propagate debate. But that’s not Xi Jinping’s and the CCP way. What Xi craves above everything else is stability, order and control. In some circumstances it will be the right thing to do, but there are a lot of issues, especially concerning the economy, where stability and control should not be the priority. The price, again, will be weaker economic growth.

In terms of China’s position in the world economy, Beijing is leading a renewed push in getting rid of what the Party leadership sees as one of its Achilles Heels, i.e. the fact that the world economy runs on the dollar. They don’t want to be in a position where the dollar could be weaponized against China.

The disillusionment with the dollar-based system is not really a new thing. It started much earlier, after Lehman. The official rhetoric from China in the wake of the GFC was that the dollar based system is no longer fit for purpose. Ever since then, they have been working on the internationalization of the yuan. This question has received a turbo charge from the decision by the US and other countries to sanction Russia after the invasion of Ukraine. So yes, they are trying to bring about a new multipolar currency system.

Can they achieve a de-dollarization?

My answer is No. This is not like changing a pair of shoes. I don’t think many of the people that advocate de-dollarization – which includes some emerging countries or the crypto crowd, which has a vested interest in undermining the dollar-based system – really have thought this through. It’s very easy to talk about de-dollarization, but to really achieve it, you’d have to turn the entire global financial and economic system on its head. I don’t think that’s going to happen. This does not mean that the dollar will forever be the dominant currency, but for the foreseeable future I don’t think it’s under a great threat.

Saudi Arabia selling crude to China for yuan, or Brazil selling soy to China and getting paid in yuan: That’s not de-dollarization to you?

If you sell products for yuan instead of dollars, you are technically de-dollarizing. But what really matters for the global monetary system is not the currency in which you settle your trade, but the currency in which you accumulate your balances. If you are Saudi Arabia and you peg your currency to the dollar, you have no use for accumulating balances in yuan. You need dollar reserves. If you are Brazil and you are exporting commodities that are globally priced in dollars, you have to accumulate liquid dollar reserves. The dollar system allows large imbalances in the global economy to accumulate because the United States is unique in allowing unfettered foreign access to all of its assets, be it bonds, equities, or real estate. If the people who are advocating de-dollarization really wanted to achieve it, it would mean that China, Germany, Japan, Brazil, Saudi Arabia, etc. would no longer be able to run current account surpluses if the US no longer accommodated their surplus savings. It would mean imposing symmetry between surplus and deficit nations. Do you really think the surplus countries would want that?

So it’s all empty talk?

Take the latest BIS Triennial Survey: The share of the dollar in reported global reserves has dropped from roughly 70% to 58% since 2000, but the gainers were the Australian and the Canadian dollar, the Swedish krona and the Korean won. These currencies are like satellite currencies of the dollar based system, they are not substitutes. The reason that people do accumulate them is because these countries also have the rule of law and liquid, convertible currencies. The yuan share of reserves has picked up from next to nothing to maybe 2,5% today. It could change if Beijing removed capital controls, making the yuan fully convertible, thereby allowing foreigners to accumulate onshore claims against China. But these changes would entail the loss of control that is greatly prized by the CCP. This might be acceptable to a future Chinese leader, but not to Xi.

What about talks about a BRICS currency?

If I twisted my own arms, I could possibly see them setting up something they might call a BRIC, which is an accounting unit for settlement of transactions, in much the same way the Special Drawing Right is an accounting unit for the IMF. But I don’t see a BRICS currency. How would it be valued? What would it be linked to? China has a convertible currency only for current account transactions, not for capital transactions. A BRICS currency is really just a fancy way of talking about a pumped up internationalization of the yuan in a way that makes the other members of the BRICS club feel better about it.

So, it’s rather simple: As long as China’s capital account remains mainly closed, there won’t be any de-dollarization?

There are certainly officials in the PBoC and government as well as a number of economists in China who think that not only is it unlikely that full internationalization can happen as long as capital controls are in situ, but also that it would be a bad idea. If they did abandon capital controls, it’s highly likely that there would be a huge outflow of capital from China. The yuan would depreciate. That would compromise the stability of the financial system in China. There is an argument that the CCP doesn’t trust its own citizens to keep their capital at home. That’s why I don’t think this is something that the CCP would ultimately endorse. Renminbi literally translates as the people’s currency. The CCP must have control over the people’s currency. Control is what drives Xi Jinping’s interest. I’m not saying it would never happen, but I am confident that it won’t happen under the leadership of Xi.

George Magnus

George Magnus is an independent economist and commentator, and Research Associate at the China Centre, Oxford University, and at the School of Oriental and African Studies, London. George was the Chief Economist at UBS Investment Bank from 1995 to 2012. He had a front row seat for multiple episodes of boom and bust in both advanced economies and emerging markets, including notably the Great Financial Crisis of 2008. George’s current book, Red Flags: why Xi’s China is in Jeopardy was published in September 2018 by Yale University Press.
George Magnus is an independent economist and commentator, and Research Associate at the China Centre, Oxford University, and at the School of Oriental and African Studies, London. George was the Chief Economist at UBS Investment Bank from 1995 to 2012. He had a front row seat for multiple episodes of boom and bust in both advanced economies and emerging markets, including notably the Great Financial Crisis of 2008. George’s current book, Red Flags: why Xi’s China is in Jeopardy was published in September 2018 by Yale University Press.