China has problems – but where does not?

Blain’s Morning Porridge, Sept 1^st 2023: China has problems – but where does not?

“The nature of Monkey was… irrepressible!” 

The news from China is unremittingly bad – a cataclysm of economic distress and woe. Combined with concerns on law and transparency, China is now off many investment lists. Yet it’s still a growing economy with a massive middle class of consumers. There are opportunities.  

This morning the headlines, yet again, are all about China weakness. Chinese data is not transparent, and we don’t really trust the numbers, but it’s abundantly clear the economy is in trouble. The PBOC has eased foreign currency reserves to shore up the Yuan. Yet, the slump in property isn’t going to be fixed by further tweaking deposits and lending multiples. The reality is: if you build too many apartments where nobody wants them… then the big property development firms will be left with massive losses as the China property bubble popped. The same kind of inevitable snap back can be seen across the whole economy.

Try to find a single positive article written about China in recent weeks – I’ll post it on the comments page! Yet, the multiple crises in China should have a certain amount of familiarity to Western readers – economic disconnects are the fate of any maturing economy.

The big issue for global investors is the ongoing investibility of China. A few years ago – in the wake of Economic crisis in the West, attracted by apparent Chinese liberalisation and the belief it would soon overtake the US, everyone wanted a slice of the Chinese economic miracle. China was always regarded as “cheap”, trading at a discount because of the lack of western style legal protections, the over-reaching power of the state, and the lack of economic and corporate transparency. These negatives were more than balanced by the strength of the economy, growth and China’s surging markets.

That has now reversed. China will still post 5% growth, but the froth has gone. It started with the crackdown on Tech barons. Since then, a cataclysm of crises have come together to apparently crush the outlook for the Middle Kingdom, presenting a horrendous macro picture, and yes, there is an element of Schadenfreude watching China suffer the same kind of issues other economies quake on. Some of the problems are unique, others simply the result of a bubble economy and deliberalisation.

Here’s a quick summation of the current China threat board:

• The long-term demographic nightmare as the nation gets old before it gets rich, raising questions about how the cost of rising social care will impact government finances.
• A developing credit crunch and banking crisis as the degree of ill-considered lending – especially by regional governments – becomes apparent.
• Chinese authorities throwing the QE dice by slashing interest rates and printing cash for bailouts, raises significant “unintended consequence” and “moral hazard” risks across the economy including future debt loads, asset-price distortion, currency weakness, and inflation.
• The property crisis (1/3^rd of GDP), and the de-facto failure of large developers, is unravelling finances – and raises the question of what kind of economic signal millions of unoccupied properties in empty cities send internationally and domestically.
• Rising Cold War tensions with the West are impacting trade, development, growth and innovation.
• Ongoing stock market weakness, with many western investors pulling back due to the lack of transparency on numbers and economic data – “due diligence” is perceived as “spying” – will continue.
• The potential of the Iron Rice Bowl compact unravelling in social tensions on the back of 20% youth unemployment raises potential political risks.
• It could get worse as China exports a deflationary bust around the globe – that will sweep back and swamp Chinese manufacturing.

There is no obvious route out for China, except figuring it out and taking the necessary steps… just like any other Western economy. Perhaps there is even a risk China will make the same kind of policy mistakes that have been made in the West!

Thus far the Chinese government has proved unwilling to embrace overly interventionist monetary policy for fear it may cause wider wealth inequality, triggering social instability.  Instead, it addressed leveraged finance by making it more restrictive, thus fuelling a credit crisis – but also exposing just how weak parts of the real economy were. Now, they appear to be reversing their caution and easing more, raising the risk the PBOC could lose face if it goes wrong. Get used to it – the BOE has!

Meanwhile, China’s face to the world has changed, trying to play parity with the West and the USA. But, attempts to boost its geopolitical heft appear to have stalled – the recent BRICS gathering may have attracted a few more members, but it’s a very diverse group of fellow travellers rather than a shared set of genuine shared convictions. The new organisation tends towards authoritarianism, and is clearly China orientated rather than a genuine independent grouping to counter US hegemony. It’s efforts to build its own global trade network, The Belt and Road, have also slowed, riven by suspicion Chinese foreign investments lack transparency, don’t discourage corruption, while unnecessary megaprojects lead to Chinese debt imperialism.

US global success was based on dollar strength, the productive capacity of the economy, leadership in consumer goods and the American dream – the whole globe bought into US culture and soft-power; Hollywood, Hamburgers, Rock’n’roll and Coke, supported by America winning the space race and cold war. China does not “get” Soft-Power. There is frankly little to attract foreigners to Chinese Surveillance Capitalism or Emperor Xi’s authoritarianism.

But no matter how bad the picture looks…. Whenever a stock market is so pummelled, or everyone has moved one-way against a particular investment, that is the moment to reconsider. As a famous French general once said: “My centre is giving way, my right is retreating, situation excellent, I am attacking.”

When it comes to China, lace up your buying boots and get ready to buy. Selectively. Very selectively.

While the economic tensions are very real, China’s economy is in transition. Mature economies struggle – deal with the reality:

• China faces slowdown.
• It’s an authoritarian state, corruption handicaps the economy (especially at regional level), which suffers economic inefficiency as a result.
• The absence of reliable and transparent economic data makes prediction and investment difficult.
• It is a nation of 1 bln plus consumers.
• It will not implode overnight.
• All these factors can be priced in.

Deal with these, and remember one of my key market mantras: “Things are never as bad as one fears, but never as good as one hopes.”

The potential economic “upside” for China is two-fold:

• China’s manufacturing export engine is not about to suddenly stop. It will remain the “cheapest to deliver” manufacturer servicing markets around the globe, enhanced by Belt and Road inputs into Africa and elsewhere. Over time, Chinese manufactures will find their cheap prices are no longer a moat against competition – but the speed at which that happens really depends on how much faster other, perhaps more nimble, Asian economies develop and raise the imbedded value of their products.
• China’s internal economy is well into its own transition towards a more consumer driven, service orientated economy. 1 billion consumers can’t be ignored. China’s internal infrastructure of fast rail, road and air links should ensure an efficient internal market (in relation to the decaying infrastructure that characterises the West) is sustained, based around online sales and working.

The trick will be picking the winners and losers, identifying Chinese and International stocks likely to benefit from however the new China economy emerges. I would remain very suspicious of state firms. China will not be so different from other mature economies – a large middle class and a top tier will continue to develop their tastes for foreign holidays and luxury goods. Meanwhile, China’s domestic economy will continue to favour its domestic mega-techs, while possibly remaining critical in global trends, like TikTok.

However, one thing could effectively zero China as an investment destination – the geopolitical implications of invading Taiwan. Emperor Xi may consider it necessary to pull the country together and show strength, but it would prove a short-term hit against long-term disaster as global markets would shut completely. I doubt China wishes to be become a pariah state like Russia.

The Chinese are more considered, cunning and smarter than the Russians. Sun Tzu makes two points that are relevant:

• “Excellence consists of breaking the enemy’s resistance without fighting”, and
• “Victory goes to the army who has better trained officers and men”

Watching the failure of Russia in Ukraine, and acutely aware the Peoples Army follows similar tactical doctrine and is similarly equipped should give Xi pause.

Five things to Read This Morning

(On the basis one should always remove the plank from one’s own eye before trying to find a splinter in the eye of a patient, read the FT article below first:)

FT                     One year in a struggling British State School

FT                     Adani share slide and politicians demand action after reports of hidden investors

WSJ                  China’s Economy Shows Fresh Weakness in Factories, Housing and Consumer Spending

BBerg               Why Putin is Worried About Russia’s Volatile Ruble

Guardian          Beware September: five cautionary tales from economic history

Out of time, back to the day job and have a great weekend!

Bill Blain

Strategist – Shard Capital