Zhou warns of ‘Black Swan’ scenario as trade war rumbles on

He has a passion for single malt whisky and opera. Puccini is believed to be one of his favorite composers. For 15 years, Zhou Xiaochuan orchestrated policy at the People’s Bank of China with reformist zeal and easy charm as he charted the country’s economic rise.

In March, he finally stepped down after steering the world’s second-largest economy through choppy waters.

First, he held his nerve during the financial crisis in 2008 before warning Beijing last year of the risks of ballooning debt in the state sector.

When Zhou speaks, central bankers across the globe listen.

Last week, he talked about the fallout from the trade war between the United States and China, which has resulted in three rounds of tit-for-tat tariffs, worth billions of dollars.

On the horizon is US President Donald Trump’s threat to impose import duties on Chinese goods worth another US$200 billion.

“The negative impact on the economy would not be significant,” Zhou said in an interview at the Ambrosetti Forum on the shores of Lake Como in Italy. “[It would be] less than half a percentage point.

“[But] we saw when the Lehman Brothers event happened, [which triggered the financial crisis], there was sudden panic and contagion, so this kind of thing is not very easy to analyze,” he added.

Strong fundamentals

While China’s economy is cooling, the fundamentals are still strong.

At the weekend, the General Administration of Customs announced that the trade surplus with the US hit a record $31.05 billion, although overall export growth dropped slightly to 9.8%, the weakest rise since March.

Factory activity also slowed while consumer inflation increased at the fastest pace since February to 2.3% in August.

As for China’s GDP, the numbers in the second quarter failed to match market expectations but the economy still expanded by 6.7%, despite Beijing’s rocky relationship with Washington.

Yet the “risk factors” loomed large at last week’s meeting of the Financial Stability and Development Committee, which was chaired by President Xi Jinping’s economic consigliere and Vice-Premier Liu He.

Discussions revolved around the “Black Swan” scenario, an “extremely rare and unpredictable economic event” outlined by Nassim Taleb, the Lebanese–American essayist and scholar, in his book of the same name.

The crash of Lehman Brothers 10 years ago, which sparked the worst financial crisis since the 1930s and paved the way for the Great Recession, is a classic example and was highlighted in Zhou’s analysis.

“[China must] prevent all kinds of ‘Black Swan’ events,” a statement released by the FSDC revealed.

Under Liu’s leadership, the financial regulator has been meeting at least once a month to assess dangers to the economy.

“There has been a change in macroeconomic regulation, as control over the economy has become more systematic,” Liu Xuezhi, a senior macroeconomics expert at the Bank of Communications, told the state-run Global Times. “Since July, there has been a rising need to respond to risks such as the recent trade tensions or weakening consumption in China.

“The committee could possibly keep on meeting every month in order to check on the state of the economy and the implementation status of reforms,” he added.

One possible ‘wild card’ would be if Trump decided to expand his tariff threats to include all Chinese imports. In July, he admitted during a television interview that he was prepared to “go to 500” billion dollars.

Beijing resolve

But even an escalation on that scale would not shatter Beijing’s resolve, according to Zhou, who was the longest-serving PBOC governor.

“The worst case scenario is that China is no longer going to export $500 billion of goods to the US market and then it’s dependent how quickly you can diversify those export goods to the other countries,” he said. “Actually, I think China could act quickly.”

Still, concerns are growing about the impact of the trade conflict on the global economy as it continues to drag on.

Shruti Godbole, a foreign policy expert at the Brookings Institution, reiterated what many academics and analysts have pointed out during the past two months that there is no quick fix to the problem.

At the heart of the row is Beijing’s economic model, including the “Made in China 2025” policy, as well as the Belt and Road Initiative, the centerpiece of Xi’s foreign investment policy.

“In terms of future projections, it appeared unlikely that either China or the United States would back down from their positions because of domestic political compulsions,” she wrote on the Washington-based think tank’s website.

“There is also a structural shift within corporate America against China, which forms a core political constituency for Trump. This means that just the settlement of trade or tariff issues is unlikely to see an end to tensions. We are therefore likely to see a systemic escalation going forward,” Godbole added.

If that happens, it would start to resemble a Puccini operatic tragedy. And Zhou would certainly see the irony in that.