It’s been exactly two years now since turmoil in China’s currency markets threw investors around the globe into panic. After the shock in late August of 2015, another tantrum followed in early 2016. Since then concerns about China have diminished. The consensus seems to be that Beijing once again has regained control. Nonetheless, Anne Stevenson-Yang remains skeptical. The co-founder of the influential research firm J Capital warns that the speculation in the Chinese real estate market is getting evermore excessive. “There is little comfort that the economy can go on for much longer without some catastrophic adjustment”, says the American who’s one of the most distinguished experts on China. She expects that China’s currency will devalue significantly and explains why the Chinese government is cracking down on HNA and other Chinese companies that have been on an overseas buying spree.

Ms. Stevenson-Yang, many investors don’t seem to care much about China anymore. How is the situation inside the Middle Kingdom two years after the currency shock of August 2015? -

 Everyone in China – from the government at every level to the people who work in banks, construction companies and real estate companies – is one hundred percent focused on how to push growth with more investment. That’s all people think about. Everybody is maniacally focused on the questions if investments will continue and if investments can continue to drive growth.

Why are investments so important to China? - The way investments drive growth for the most part this through housing prices. So for the average middle-class or upper-class person in China the focus is all on how much will property prices increase this year.  They are not thinking about questions like: How can I get my salary to go up? Or how can my children get a better education so they can get a better job? They are not thinking about these fundamental economic things. They are thinking about things like: “Oh my god, I bought this villa in Langfang. The price is up 40%. Should I sell now? Or will it go up another 60%?” That’s what the government is thinking about, too, because that’s the way to drive growth and the way they get people excited and to get them to buy into the idea of the great Chinese miracle.

There have been warnings about a bubble in China’s housing market for some time now. How hot is the real estate market? - So far this year has been crazy, particularly in the area around Beijing. Just a few weeks ago I was in this little rustbelt city called Zhuozhou in the Hebei province where the steel mills are. It’s a very unpleasant place to spend time. It’s very polluted, there’s nothing to do, the food is bad and the landscape is awful. It’s just no place you want to be and yet property prices have doubled, tripled and in some places even quadrupled in a year.

What’s fueling this boom? - It’s like in every property bubble: People build these stories. In Florida for example, the idea in the housing bubble was that all Americans are going to retire there. Florida has nice beaches, it’s warm and Americans are getting older, so everybody’s going to retire there. In China, the idea is that all these areas 200 miles outside of Beijing are going to be bedrooms for the working class of Beijing. So they’re going to build subways, schools, hospitals and other public facilities there and the prices are going to go up. The story goes that all these people who can’t afford to live in Beijing but work there are going to live in places like Zhuozhou instead and that they are going to take the high speed rail into Beijing. Everybody is speculating like mad but in the end nobody wants to live there.

And how are such ghost towns financed? - There is probably no company that is more representative of the investment bubble than Evergrande. It’s the biggest pyramid scheme the world has yet seen. Evergrande is highly leveraged and has like 270 projects all over the country. I have been easily to 40 of them yet I have only seen one that was fully occupied. Many of these projects are megalomaniac visions and totally empty. Yet you go to these places and you see their sales room filled with young buyers. When I open my eyes I see crumbling stone and empty jungles or deserts. What they see is a future with wealthy Europeanized people strolling on modern paths. It’s just amazing. It’s a mass illusion and Evergrande more than any of these developers plays to this illusion by building developments that are specifically positioned for the investor, not to live there but to buy for some future appreciation in price.

How long can these crazy times last? - I’ve been wondering that for years now. In a few places, property bubbles already have popped but the government keeps information from going out. Back in 2011 for instance, there was a property bust in the region of Ordos where most of China’s coal is. Prices dropped like 50% but if you looked at the official statistics they may have dropped 4%. Another place was in Wenzhou which is a place in China’s Zhejiang province where there is a lot of private money. After the bubble popped the central government had to go in and had to create a bailout fund. But nobody ever got information about it. In fact, all the newspapers put out information about how actually Wenzhou is fine.

So will China’s housing frenzy ever come to an end at all? - China is going to hit a wall. They’re not positioned to take the political pain that’s entailed by just stopping with all that madness. So there will be a bust but it’s very hard to say exactly how long it takes. Basically, there are two paths. One of them is you break public confidence in some way. For that to happen you have to have a bank failure, a well-known investment product that doesn’t pay or some property developer that goes bust. You’ve had that locally in all sorts of places but you have to have a really big bust that everyone is aware of.

And what would be the other path? - The other thing that eventually has to happen is that the Chinese currency has to devalue. The reason why the developers can just keep on selling is because they keep getting refinanced. All the refinancing means that China has to keep on expanding the money supply and when you keep on expanding the money supply you have too much money and the value of the money declines. Obviously it’s not quite that simple but that’s basically what’s going on. For now, the only reason foreign corporations like BMW or Swatch Group are willing to take exchange rate of around 6.7 Renminbi to the dollar is because the Chinese government is standing behind the exchange rate paying those dollars. But at some point that has to stop because the Chinese government won’t have those dollars anymore.

Then again, the outflows of China’s foreign exchange reserves seem to have stopped. - Certainly they have cooled down since 2015/16. But that’s more of a pause than anything else. Also, China had a lot of advantage from the weak dollar recently. What’s more, I think there is also a lot of monkeying in the numbers. If you look at all the accounts other than the US dollar reserves and other hard currency reserves, they run flat to negative every month. And yet they show rising reserves in total. So if you want to be generous then you can say: maybe they are telling the truth but it’s all valuation improvements. If you want to be less generous about it, you can say they’re just fudging the numbers. So one way or the other: China has not reported any incoming hard currency.

Another mystery is China’s cracking down on companies like HNA that have been very active overseas in terms of acquisitions. What’s your assessment of these interventions? - It all began with the insurance regulators. In February, they kidnapped Xiao Jianhua, the head of the private Hong Kong insurer Tomorrow Group, and took him back to the mainland. He is viewed as some type of family office manager to the high families in China. That means he knows a lot about who has money in China and where. Nobody really knows what’s going on with him, if he’s alive or not. He has certainly been under interrogation. Since that time, there have been a lot of regulatory actions against insurance companies. First the chairman of the insurance regulatory commission stepped down and was prosecuted. And now, companies like HNA, Wanda, Anbang and Fosun are under investigation. Their communality is that they all raise money from the public through insurance products which in reality are mainly investment products with a little tiny bit of insurance attached.

And where’s the link to the overseas acquisitions? In Switzerland for example, HNA has bought several companies, among them Gategroup, and just recently became the largest shareholder of the travel retailer Dufry. - HNA and the other companies have been raising money from these investment products and then using that money to buy overseas assets. They haven’t necessarily swapped the currency. But what you can do is you can deposit Renminbi in China and then take a loan from an overseas bank based on that deposit. So you could theoretically default on that deposit and still have the hard asset.

What’s the problem with that? - That means you’re basically exchanging Renminbi for dollars. The regulators don’t want these companies to take out the extra liquidity that the People’s Bank of China is putting into the domestic economy and transfer it overseas. That’s the issue. There are some elite power dynamics going on as well but we can only speculate on that. What we do know is that they don’t like it when people are taking money out of China.

This fall, all eyes are going to be on the 19th National Congress of the Communist Party. What will this major event mean for the future course of China? - Here’s an interesting thing: a lot of analysts within China have opinions about which politicians on the Politburo will remain and which politicians will step down. But if you ask anybody about what difference does it make, nobody has an answer. That just tells you it surely makes a difference. But we just don’t know what the difference is. Nobody knows except the people within the Chinese government. Also, in China, when you retire from a high government position you’re not allowed to leave the country. So there’s a kind of universal code of Omertà that no one breaks. That’s why there’s so little that we understand about Chinese elite politics and how the government with its different factions and infights works. Who’s against whom? Who’s fighting for what? Nobody has any idea.

What’s the perception of Chinese President Xi Jinping with respect to the new administration in the United States? - When Donald Trump was elected everybody in the Chinese government was happy. They were saying “Wow, this is the luckiest thing that ever happened to us, even better than Brexit“. Then Trump invites Xi to his “palace” in Florida. He has his grandchildren sing Chinese nursery rhymes and thinks he made a deal. But in reality, China is laughing all the way to the bank.

Why? - Because they were looking forward to a weaker United States and to a weaker dollar. And the weaker the dollar is the stronger the Renminbi is. In addition to that, Trump talks a lot of his great plans for the US economy. But his only agenda for himself is to undo Obama’s legacy. Of course, with the Republican Party it’s a little bit different. But that’s Trumps goal. China had its headaches with the Obama administration. One of the things that China most disliked was the Trans Pacific Partnership agreement which would have been of high advantage to the United States and US corporations. That’s why China hated the PPT and it spend a lot of time stewing over it. So of course China loved it when Trump came in and said: “The US is stepping out of the TPP“.

Now, the world looks with unease at the growing tensions between North Korea and the United States. What’s the take in Beijing on this lingering conflict? - People often project to China great geostrategic goals that are not really there. Also, China probably has less control over North Korea than we think. In general, it seems that China never really wants to involve itself with the rest of the world when it comes to influence and change with respect to international organizations. It’s more like China participates in order to take what it needs at the moment. There’s a remarkable lack of strategic vision and long-term guidance. That’s true for aspects of diplomacy as well as security.

Yet China invests heavily in defense, builds its own aircraft carriers and has built new military facilities on artificial islands in the South China Sea. - In contrast to the United States, China doesn’t have a lot of military bases in Asia. So it’s definitely anxious about the power of the US in the region. But you can’t extrapolate from this that China wants to step into the role of the US because empirically that’s simply not true. It’s not the case because China is peaceful or incapable. It’s because China’s external goal is all about making money for the government and for Chinese corporations. It’s purely a mercenary interest. So I doubt that China is ready to take advantage of the weakness of the United States. Probably that advantage goes to someone else and my bet right now is on Europe.

Nevertheless, China’s economy has seen an astonishing rise and the country is now the second largest power in the global economy after the United States. - In the West, we tell ourselves this narrative about a rising people who are taking their place in the world. But when you look at the simple evidence in front of your eyes what you have is a very small group of powerful people in the government who have managed to aggregate enormous resources and waste them on empty projects to fill their own pockets. But that does nothing for the people. That’s not to say that the Chinese people themselves have not achieved great economic progress over the last thirty years. But a big chunk of their economic wealth is being stolen.

So what does that all mean for investors? - That doesn’t mean that China is a pile of junk. There are a lot of good companies and there is a lot of strength in the Chinese economy. We will see that after the burst of the bubble and after the country has gone through a couple of years of recession and the Renminbi has devalued a lot. Then, China will gradually come back, the investment portion of GDP will drop and the consumption portion of GDP will rise. Among other things, this means improving margins for food and drink companies like Tingyi and Vitasoy. So on a long term perspective their stocks look a lot cheaper than they are now.

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