Is the Bubble Economy Set to Burst?


My friend Andy Xie, based in Shanghai, is a very independent-minded investment analyst and economist. With a PhD from MIT, he has been at the IMF and was a star economist for the Morgan Stanley Asia-Pacific group. His ofttimes bearish calls on various parts of the Chinese economy have elicited a lot of criticism from Chinese officials and retail investors. I have been on the stage with him several times, both on the same side of debates and on opposite sides – he is a formidable opponent! We do have one thing in common: While we may be often wrong, we are seldom in doubt and certainly not afraid of letting others know what we think. Forcefully.

This week Andy posted an essay in the South China Morning Post: “The bubble economy is set to burst, and US elections may well be the trigger.” I find that interesting. Here I am looking at the problems in China as potentially triggering global problems, and he is looking at elections in the US.

Andy says of himself that he has a reasonably good record at calling bubbles:

I wrote my doctoral thesis arguing that Japan was a bubble in late 1980s, a long report at the World Bank in the early 1990s arguing that Southeast Asia was a bubble, research notes at Morgan Stanley in 1999 calling dotcom boom a bubble, and numerous research notes from 2003 onwards arguing that the U.S. property market was a bubble. On the other hand I have never called something a bubble that turned out not to be a bubble.

In today’s Outside the Box Andy looks at what he thinks is the cause of the current bubbles that he sees around the world: central bank intervention. And I agree. I find it fascinating that Yellen & crew are puzzled at the lack of inflation in their CPI measure but don’t see a problem with inflation in asset prices. In fact, they see rising home prices and nosebleed-high stock prices as good things and are quite proud of having fostered those. The fact that they came along with credit bubbles around the globe, fostered by ultra-low rates, is something they are willing to ignore.

I know that Trump is going to be appointing a new Fed chair and Fed governors, but I have to tell you, there is simply not enough money to make me want to sit around that table and be responsible for cleaning up the mess that the present denizens have created. I think the FOMC is going to find itself in a situation where they have no good choices, and probably not even merely difficult ones. But they will be forced, or at least feel like they are forced, to “do something”; and that something is going to once again take the form of lower rates and more quantitative easing –and maybe even a few little innovations like negative rates and asking Trump and Congress for permission to shift out of their normal “We can only buy government-backed assets” mode. Much as the Bank of Japan, the ECB, and the Swiss National Bank have done. (Trivia: The Swiss National Bank owns almost 2% of Apple. How much more do they have to buy before they want a board seat? [That’s a joke, gentle reader.] But it does take 66 pages to print a list of all the stocks the SNB owns.)

I am more convinced than ever that we are rapidly moving into a world where the unthinkable –and I mean truly unthinkable – is going to be not only thought about but acted upon. Damn the torpedoes and all that stuff. I think you will enjoy Andy’s insights.

Now, the kitchen is calling me: I have a very large prime roast, chili, and mushrooms to make. Shane is also going to make chili for the guests that are a little less tolerant of “heat.”

There are some 15 independent advisors and brokers from around the country coming over, along with my various partners and associates. These evening dinners have evolved into a meet and greet with hors d’oeuvres and wine, then the food, and then we all move to the “family room” (it’s really just a big open space) where I sit on a high stool and answer questions. We start by asking these advisors what is the one thing their clients are most worried about and what is the one thing they themselves are most worried about. It makes for a provocative conversation.

I woke up yesterday morning finally feeling normal again and able to sit down and begin to work through my email inbox, where I found 415 messages. That’s after I deleted the obvious ones. Sigh – I know what I will be doing for a few days. You have a great week, and try not to let your inbox overwhelm you – get out and do something fun.

Your wondering how central banks get off the horns of this dilemma analyst,

John Mauldin, Editor
Outside the Box



The bubble economy is set to burst, and US elections may well be the trigger

By Andy Xie

Central banks continue to focus on consumption inflation, not asset inflation, in their decisions. Their attitude has supported one bubble after another. These bubbles have led to rising inequality and made mass consumer inflation less likely.

Since the 2008 financial crisis, asset inflation has fully recovered, and then some. The US household net worth is 34 per cent above the peak in 2007, versus 30 per cent for nominal GDP. China’s property value may have surpassed the total in the rest of the world combined. The world is stuck in a vicious cycle of asset bubbles, low consumer inflation, stagnant productivity and low wage growth.


 
The US Federal Reserve has indicated that it will begin to unwind its QE (quantitative easing) assets this month and raise the interest rate by another 25 basis points to 1.5 per cent. China has been clipping the debt wings of grey rhinos and pouring cold water on property speculation. They are worried about asset bubbles.

But, if recent history is any guide, when asset markets begin to tumble, they will reverse their actions and encourage debt binges again.

Recently, some central bankers have been puzzled by the breakdown of the Philipps Curve: that falling unemployment rates would lead to wage inflation first and consumer price inflation next. This shows how some of the most powerful people in the world operate on flimsy assumptions.

Despite low unemployment and widespread labour shortages, wage increases and inflation in Japan have been around zero for a quarter of a century. Western central bankers assumed that the same wouldn’t happen to them without understanding the underlying reasons.

The loss of competitiveness changes how macro policy works. Japan has been losing competitiveness against its Asian neighbours. As its population is small, relative to the regional total, lower wages in the region have exerted gravity on its labour market. This is the fundamental reason for the decoupling between the unemployment rate and wage trend.

The mistaken stimulus has the unintended consequences of dissipating real wealth and increasing inequality. American household net worth is at an all-time high of five times GDP, significantly higher than the bubble peaks of 4.1 times in 2000 and 4.7 in 2007, and far higher than the historical norm of three times GDP. On the other hand, US capital formation has stagnated for decades. The outlandish paper wealth is just the same asset at ever higher prices.

The inflation of paper wealth has a serious impact on inequality. The top 1 per cent in the US owns one-third of the wealth and the top 10 per cent owns three-quarters. Half of the people don’t even own stocks. Asset inflation will increase inequality by definition. Moreover, 90 per cent of the income growth since 2008 has gone to the top 1 per cent, partly due to their ability to cash out in the inflated asset market. An economy that depends on asset inflation always disproportionately benefits the asset-rich top 1 per cent.

There have been so many theories on why inequality has risen. The misguided monetary policy may be the culprit. Germany and Japan do not have significant asset bubbles. Their inequality is far less than in the Anglo-Saxon economies that have succumbed to the allure of financial speculation.

While Western central bankers can stop making things worse, only China can restore stability in the global economy. Consider that 800 million Chinese workers have become as productive as their Western counterparts, but are not even close in terms of consumption. This is the fundamental reason for the global imbalance.

China’s model is to subsidise investment. The resulting overcapacity inevitably devalues whatever its workers produce. That slows down wage rises and prolongs the deflationary pull. This is the reason that the Chinese currency has had a tendency to depreciate during its four decades of rapid growth, while other East Asian economies experienced currency appreciation during a similar period.

Overinvestment means destroying capital. The model can only be sustained through taxing the household sector to fill the gap. In addition to taking nearly half of the business labour outlay, China has invented the unique model of taxing the household sector through asset bubbles. The stock market was started with the explicit intention to subsidise state-owned enterprises. The most important asset bubble is the property market. It redistributes about 10 per cent of GDP to the government sector from the household sector.

The levies for subsidising investment keep consumption down and make the economy more dependent on investment and export. The government finds an ever-increasing need to raise levies and, hence, make the property bubble bigger. In tier-one cities, property costs are likely to be between 50 and 100 years of household income. At the peak of Japan’s property bubble, it was about 20 in Tokyo. China’s residential property value may have surpassed the total in the rest of the world combined.

How is this all going to end? Rising interest rates are usually the trigger. But we know the current bubble economy tends to keep inflation low through suppressing mass consumption and increasing overcapacity. It gives central bankers the excuse to keep the printing press on.

In 1929, Joseph Kennedy thought that, when a shoeshine boy was giving stock tips, the market had run out of fools. Today, that shoeshine boy would be a genius. In today’s bubble, central bankers and governments are fools. They can mobilise more resources to become bigger fools.

In 2000, the dotcom bubble burst because some firms were caught making up numbers. Today, you don’t need to make up numbers. What one needs is stories.

Hot stocks or property are sold like Hollywood stars. Rumour and innuendo will do the job. Nothing real is necessary.

In 2007, structured mortgage products exposed cash-short borrowers. The defaults snowballed. But, in China, leverage is always rolled over. Default is usually considered a political act. And it never snowballs: the government makes sure of it. In the US, the leverage is mostly in the government. It won’t default, because it can print money.

The most likely cause for the bubble to burst would be the rising political tension in the West. The bubble economy keeps squeezing the middle class, with more debt and less wages. The festering political tension could boil over. Radical politicians aiming for class struggle may rise to the top. The US midterm elections in 2018 and presidential election in 2020 are the events that could upend the applecart.


The tug of war grows more fraught for investors

The IMF and World Bank meetings mixed optimism about the global economy with plenty of concerns

by Mohamed El-Erian
.

© Bloomberg


A “Yes, but” emerged from last week’s global gathering of policymakers that provides a comprehensive check-up for the global economy. In Washington for the 2017 Annual Meetings of the International Monetary Fund and World Bank, officials from almost 190 countries mixed excitement about the improving prospects for the global economy with caution about a list of actual and potential challenges.

And with both sides of this ledger having grown during the past few months, it is a configuration that amplifies the contradictions that traders and investors have to navigate down the road but, for now, are comfortable to profitably ignore.

Four factors underpin the “Yes”:·

- A pick up in economic growth that is becoming broader and more durable. The IMF now projects global growth to increase from 3.2 per cent last year to 3.6 per cent in 2017 and 3.7 per cent in 2018.

- Loose financial conditions that support consumption, and do so without a worrisome increase in inflation and inflationary expectations.

- Very low financial market volatility that, now common to virtually all market segments, allows the wave of higher valuations to reach far and deep.

- Hope that economic growth could be turbocharged by long-awaited progress in implementing more pro-growth policies, particularly in Europe and the US.

The “But” list includes:

- Limited understanding of key economic relationships in advanced countries (such as productivity, wage determination and inflation dynamics), as well as the impact of technological innovation.

- The “hot potato” dimension of today’s foreign exchange markets in which virtually no country is able and willing to live with a sustainably stronger currency.

Uncertainties about the impact of an eventual normalisation of monetary policy in more than one systemically-important central bank, together with those relating to trading arrangements in Europe and North America.

- Growing backlash against big tech in the context of a catchup, both by governments and the companies themselves, to the sector’s systemic importance.

- An international economic order facing greater probability of fragmentation along national and regional lines.

- The geopolitics of North Korea’s brazen nuclear threats.

- Persistent inequalities that fuel the politics of anger, social divisions and party polarisation.


While both sides of this ledger have increased over time, traders and investors have been profitably focusing elsewhere — that is, applying a “buy-the-dip” (any dip) strategy that has served them well. It involves ever greater exposures to credit, liquidity and volatility risks that, over the past few months, have spread from advanced countries’ stocks and bonds to virtually every corner of the public markets around the world. And it is a phenomenon that is being structurally embedded through the proliferation of a growing array of low-cost passive products, notably ETFs, that implicitly promise investors instantaneous liquidity at reasonable bid-offer spreads in asset classes that, in the past, have suffered numerous liquidity strains.

Over time, this confluence of factors sets the global economy and markets on course for a tug-of-war among dramatically opposing possible outcomes. If the “Yes” prevails, the result would include higher and more inclusive growth, a validation of elevated asset prices, the orderly normalisation of unconventional monetary policy, reduced cross-border tensions and an improved environment for national politics. However, a decisive tip towards the “But” would threaten recession and unsettling financial instability, increase the risks of a policy mistake, worsen trade and currency tensions, and fuel more divisive national politics.

It is very hard to predict with a high enough degree of confidence the timing and direction of the eventual resolution. In the meantime, only major disruptions are likely to dissuade traders and investors to abandon what most dream of — a strategy that reliably rewards them and even has some legitimate justification (that is, the ample availability of liquidity from central banks and the corporate sector). In the meantime, both sides of the ledger will continue to grow.


Mohamed El-Erian is chief economic adviser to Allianz and author of the book ‘The Only Game in Town’


Buttonwood

Higher taxes can lower inequality without denting economic growth

A new study by the IMF finds no strong correlation between lower taxes and higher growth



INEQUALITY is one of the big political issues of the 21st century, with many commentators citing it as a significant factor behind the rise of populism. After all, nothing could be more indicative of the triumph of the common man than the elevation of a property billionaire to the American presidency.

A new IMF report* looks at how fiscal policy can help tackle inequality. In advanced economies, taxation already has an impact. The Gini coefficient (a standard measure of income inequality) is around a third lower after taxes and transfers than it is before them. But whereas such policies offset around 60% of the change in market inequality between 1985 and 1995, they have had barely any impact since.

That is because of a change in policy direction. Across the West, taxes on higher incomes have generally fallen. This could be for a number of reasons, the IMF says. The tax take from high earners could have become more “elastic” (ie, sensitive to rate changes); in a mobile world, the elite will move countries to reduce their tax bills. But there is no sign that elasticity has increased in recent decades. A second possibility, easily dismissed, is that the share of income taken by the rich might have fallen; it has, of course, increased. A third option is that society reached a consensus that tax rates needed to be cut to help the rich. In fact, surveys show that people are more in favour of redistributive policies than they were in the 1980s.

Another reason that governments might have driven down top tax rates could be to create greater incentives to invest, thereby boosting economic growth. That certainly seems to be the rationale behind the cuts being proposed by President Donald Trump.

But the IMF, after analysing tax rates in OECD countries between 1981 and 2016, found no strong relationship between how progressive a tax system is and economic growth. Indeed the study adds that for countries wanting to redistribute wealth, there may be “scope for increasing the progressivity of income taxation without significantly hurting growth”.

The latter sentence will be seized on by politicians on the left. But the argument works better in some places than in others. The IMF reckons that the optimal tax rate on higher incomes, assuming the aim is revenue maximisation, is 44%. Britain’s highest rate is already 45%. So the IMF study does not really provide much ammunition for Jeremy Corbyn, the leader of the Labour Party, the main opposition, who wants to raise it to 50%. It is a better argument, perhaps, for Bernie Sanders, the Democrat, since the top American tax rate, before any Trump cuts, is only 39.6%.

Even here, a note of caution is needed. Companies are inclined to move in search of more favourable tax treatment—hence the success of Ireland in attracting business with its 12.5% corporate-tax rate, and the row about “inversions” where American companies move overseas to lower-tax jurisdictions. In response, countries have steadily lowered corporate-tax rates; since 1990 the average rate in advanced economies has fallen by more than 13 percentage points (see chart).

Many rich individuals can choose to shift the way they report their income to take advantage of lower corporate-tax rates. So it is difficult to push up the tax rate on individual incomes while simultaneously lowering the corporate rate. As the IMF report drily remarks: “International tax co-ordination could potentially address this problem but has proved very difficult to implement.” So are there other ways to reduce inequality via the tax system? Another option discussed by the IMF is taxing property, which is an immovable asset. Inheritance taxes are another possibility, although they are costly to administer, and no G7 country raises more than 1% of GDP through this route.

Given the political clout of the rich, it seems unlikely that an international consensus on reducing inequality through higher taxes is going to emerge. In the absence of such a consensus, few governments will take the risk of raising their own rates unilaterally. Step forward, however, a future Corbyn government, which plans to increase the tax rate on companies as well as on individuals—all in the context of Brexit, when companies might in any case be reconsidering their decision to invest in Britain. It will be an economic experiment closely watched by other countries, suggesting a new national slogan: “Britain—we try policies so you don’t have to.”


Don’t Bank on Bankruptcy for Banks

Mark Roe
 .

As a part of their efforts to roll back the 2010 Dodd-Frank Act, congressional Republicans have approved a measure that would have courts, rather than regulators, oversee megabank bankruptcies. It is now up to the Trump administration to decide if it wants to set the stage for a repeat of the Lehman Brothers collapse in 2008.

 
CAMBRIDGE – In the next month, the US Treasury Department is expected to decide whether to seek to replace the 2010 Dodd-Frank Act’s regulator-led process for resolving failed mega-banks with a solely court-based mechanism. Such a change would be a mistake of potentially crisis-size proportions.
Yes, creating a more streamlined bankruptcy process can reduce the decibel level of a bank’s failure, and bankruptcy judges are experts at important restructuring tasks. But there are critical factors that cannot be ignored. Restructuring a mega-bank requires pre-planning, familiarity with the bank’s strengths and weaknesses, knowledge of how to time the bankruptcy properly in a volatile economy, and the capacity to coordinate with foreign regulators.
 
The courts cannot fulfill these tasks alone, especially in the time the proposal under consideration has allotted – a 48-hour weekend. Unable to plan ahead, the courts would enter into the restructuring process unfamiliar with the bank. Moreover, the courts cannot manage the kind of economy-wide crisis that would arise if multiple mega-banks sank simultaneously.

And they cannot coordinate with foreign regulators.
 
In short, completing a proper restructuring would require contributions from regulators, including pre-planning, advice, and coordination. Yet, far from accepting these contributions, the plan would largely cut regulators out of the process.
 
For example, the plan would bar regulators from initiating a mega-bank’s bankruptcy, leaving it to the discretion of the bank’s own managers. In the nonfinancial sector, failing companies often wait too long before declaring bankruptcy, so creditors may step in to do some pushing, potentially even forcing a bankruptcy of a failed firm. While bank regulators have tools to push banks similarly, their most effective one is the power to initiate a bankruptcy when it is best for the economy.
 
Taking this tool away could have severe adverse consequences. Bank executives, like sinking industrial firm executives, have reason to “pray and delay,” hoping that some new development will save them. But if a failing mega-bank runs out of cash during such a delay, the risk that its bankruptcy will be disorderly – as with Lehman Brothers in 2008 – rises, as does the potential that it will wreak havoc on the real economy.
 
The simple fact is that government regulators can do things that courts cannot. Courts lack the staff and expertise to come up with a nation-wide recovery plan. Moreover, they cannot lend to a cash-poor wobbly bank until it can stand on its own. The government can do that – and it can make sure that either the bank will repay the loans (by getting good collateral) or that the financial sector overall will cover the repayment (as Dodd-Frank authorized and required).
 
When courts preside over nonfinancial bankruptcies, they depend on private lenders to provide emergency liquidity. But in a financial crisis, weakened banks cannot lend, meaning that the government must serve as the lender of last resort. And to play that role well, the government must be deeply involved in the bankruptcy process, so that it can jump in if needed.
 
The current proposal, which the US House of Representatives has already passed, has other major flaws. For starters, American mega-banks operate worldwide, typically with a significant presence in London and other financial centers. If creditors and depositors of a failed American mega-bank’s foreign affiliate run off with the cash they held there, or if a foreign regulator shuts down that affiliate, the US bank would be in an untenable position. Yet courts cannot negotiate understandings with foreign regulators. American regulators can, but only if they can control the timing of the bankruptcy, and otherwise engage in the process.
 
To be sure, the bankruptcy bill now in play is useful. But it is not robust. It would not allow broad-spectrum, full-scale bankruptcies, in which failing operations are closed under the court’s aegis, viable operations are sold, and debts are restructured up and down a company’s balance sheet.
 
Rather, the current proposal envisages a limited-scale weekend restructuring, requiring that a precise loan structure be put in place years ahead of time. The bank would be closed on Friday evening, unburdened of pre-positioned evaporating debts over the weekend, and reopened on Monday morning, without (in the best-case scenario) needing a government bailout.
 
If successful, this kind of rapid-fire bankruptcy process would be valuable. But it has never been tried. To have any chance of re-opening on Monday morning, a bankrupt bank’s billions of dollars in long-term debt would already have to be structured in such a way that a bankruptcy court could eliminate it over a weekend.
 
But bankruptcy judges would have no knowledge in advance of a bank’s debt, and they would need more than a weekend to determine whether that debt could be properly stripped out. Government regulators, on the other hand, could do this in advance. And yet, under the current proposal, their official means of doing so would be sharply rolled back.
 
Bankruptcy, if it works, is a good way for a failing firm to restructure or shrink. But if a failing mega-bank cannot open on Monday morning, the financial system will need backup. Under the current proposal, the absence of a regulatory safety net could result, if the weekend restructuring fails, in a global chaotic free-for-all, just like the one that followed the 2008 Lehman Brothers bankruptcy.
 
Maintaining financial stability in a crisis is too important for us to pin our hopes on a narrow bankruptcy channel. The courts can help, especially after they have developed a routinized process for restructuring banks, as they have done with airline restructurings. But we should be wary about relying on courts to do things they have never been asked to do before.
 
The House already voted, precipitously, to replace the regulator-led restructuring system with a weaker court-led setup. Let’s hope that wiser heads at the Treasury Department prevail.
 
A letter to Congress with a similar conclusion was signed by 120 academics with expertise in bankruptcy, banking regulation, finance, or all three.


Mark Roe is a professor at Harvard Law School. He is the author of studies of the impact of politics on corporate organization and corporate governance in the United States and around the world.


In China, a New Political Era Begins

By Matthew Massee

     
The world has changed since modern China was founded, and it seems that China, not for the first time, is changing with it. When Mao Zedong established the republic in 1949, having fought a civil war to claim it, China was poor and unstable. To reinstate stability he ruled absolutely, his government asserting itself into most other state institutions. Private property was outlawed, and industrialization was mandated, from the top down, in an otherwise agrarian society. The goal was to disrupt China’s feudal economic system that enriched landlords but left most of the rest of the country in poverty. Mao’s techniques ensured compliance with government policies, but they did little to improve the country’s underdeveloped economy. This is what we consider the first era of communist rule.

When Mao died in 1976, his successor, Deng Xiaoping, made economic development his utmost priority. He liberalized some of Mao’s policies, allowing foreign trade in some areas and private ownership in others, and so ushered in the beginning of China’s economic miracle. The country prospered, but it did so unevenly. The coastal provinces became wealthy while the impoverished interior regions floundered. Liberalization meant less government control, but with less control, military and economic elites began to pursue their own interests, which sometimes ran counter to those of the party. Central leaders became comparatively less important. This is what we consider the second era of communist rule.

Chinese President Xi Jinping delivers a speech at the opening session of the Chinese Communist Party’s Congress at the Great Hall of the People in Beijing on Oct. 18, 2017. WANG ZHAO/AFP/Getty Images
 
The third era of modern China may well have begun on Oct. 18, the first day of the 19th National Congress of the Communist Party. President Xi Jinping basically said as much in his opening speech, noting that he would raise his country’s influence abroad and lower its poverty rates at home. To do that, however, Xi believes he must blend the policies of Deng and Mao – in other words, he must liberalize with an iron fist. This explains why, over the past five years, he has steadily accrued more power than almost any other leader, using anti-corruption as pretext to purge his political enemies. He has disciplined several party figures and replaced them with officials loyal to him. He has implemented a variety of military reforms. And he has centralized economic management more than it already had been – something he believes is necessary to remove the biggest impediments to Chinese growth and stability: uncontrolled maritime territory and an imbalanced economy.
 
The Protection of Rights
The Chinese economy depends heavily on exports, but the country’s geography is all but hostile to land-based trade. It therefore relies heavily on the world’s sea lanes to bring its wares to market. One of China’s geopolitical imperatives – something it must to do survive and thrive – is to guarantee trade through the East China Sea and South China Sea, areas to which Beijing has laid exclusive claim. (Nearly 40 percent of China’s total trade in 2016 transited through the South China Sea, according to the Center for Strategic and International Studies.) Put simply, these waters are so important to China’s economy that Beijing cannot afford to lose them. The government is aware of how vulnerable this dependence makes the country, and it is likewise aware that the United States, the world’s foremost naval power, could exploit it if a conflict between the two broke out.
 
 
One way to overcome this weakness is to overhaul China’s navy and air force. This is why, in his Oct. 18 speech, Xi said China intends to fully modernize its military and enhance the nation’s defensive capabilities by 2035. The stated rationale is to protect maritime rights and to engage in counterterrorism, disaster relief, peacekeeping and humanitarian relief. But the tacit reason is to protect its own maritime rights.
Some reforms are already underway. In 2014, for example, Xi reduced the number of military command regions from seven to five, and all armed forces were placed into joint groups to better coordinate their operations. Earlier this year, the People’s Liberation Army announced that it would cut 300,000 soldiers because modernization requires technological applications, not manpower. The central government is asserting dominance over the PLA and preventing alternative centers of power from arising. This, coupled with an increasing defense budget with a heavy focus on technological upgrades, will remake the armed forces into a more effective, modern fighting force.
 
Money to the Middle
History tends to repeat itself in China. Over the centuries, when Beijing opened up its economy, it generated wealth that usually never made it in to the rural interior provinces. The disparity created enough of an economic imbalance between the rich coast and the poor interior that the government needed to turn inward to reunite the country.
 
For China, that moment approaches again. The Deng era helped China to become wealthy, but the coastal provinces have benefited far more than the interior. For Chinese leaders, this is palatable during times of prosperity, but when economic growth slows, as it has recently, it creates a problem for the Communist Party, the legitimacy of which depends on keeping people wealthy enough – or at least well-enough fed – to not rebel against it. After all, the party came to power in a revolution of the people, not of the elite. Xi sees the risk and knows what’s at stake. So far, his approach in mitigating the risk has been to centralize power by taking it away from the provinces and suppressing political and social dissent.

Centralizing power, however, is just the first step in Xi’s plan to right the economy. The next step involves real measures to reduce economic inequality. (Xi’s government intends to eliminate rural poverty by 2020.) To that end, Beijing has directed infrastructure development to poor areas to help jumpstart growth. To encourage foreign capital inflows, China will create a more unified national investment environment. Instead of each foreign trade zone having its own “negative list” that determines which sectors foreign investors are allowed to participate in, Xi plans to make a national list, which would grant the central government more control over provincial and municipal economic managers, and allow it to incentivize investment outside of coastal provinces.

The goal is to get money into the interior. Over the past two years, Beijing has also placed restrictions on capital outflows from domestic sources to encourage investment in the nation’s inner provinces and discourage capital flight. Until now, coastal firms and wealthy investors have tended to put their money into foreign assets such as sports teams and hotels, which increased capital scarcity and forced the People’s Bank of China to sell foreign assets to stabilize the yuan. Investments in foreign countries now require approval to ensure they are either to gain technology in strategic industries or to fund One Belt, One Road projects.

Generally, it’s a mistake to overemphasize the importance of political speeches. But Xi’s was no ordinary speech. Over the past five years, he has instituted sweeping changes in a country resilient to change and has enhanced his power at the expense others. The people like him. Officials fear him. The military has been reorganized around him. And economic growth under him has declined slowly and steadily, not sharply or dramatically. In other words, his speech is notable, especially since it came during what is, by many accounts, the formalization of his power and policies.