What’s the real story in China?

Blain’s Morning Porridge – Jan 27th 2023: What’s the real story in China?

“It is difficult to catch a black cat in a dark room. Especially when it is not there.”

This morning: While the rest of the world hiked to fight inflation, China has embarked a sprint to reopen the economy; easing rates, mortgages, property lending and loans. The question is can it succeed when demographics, trade and the laws of growth may have already moved against them?

While the UK economy has flatlined, the US saw growth of 2.9% in Q4 2022. Although the numbers show signs of inventory building rather than sales, and employment is no longer so hot, the US economy is marginally more likely to avoid recession on the back of still buoyant consumer spending. That’s the trick to a successful economy: jobs and consumers consuming! The British seem to have lost sight of that somewhere in the latest iteration of Tory Austerity dogma, but you can be sure the Chinese understand it.

China – what next?

There is nothing more preposterous than writing about the Chinese economy from the comfort of my comfy chair here in England – the best I can do is listen, watch and read what I can from the Middle Kingdom and try to make sense of it all.

For the last few years discovering what was really going on in China has been the difficult thing. It’s been impossible to really know how policies were impacting at street and individual business level because of Covid restrictions and the refinements made to China’s surveillance capitalism – which made the job of analysts pretty impossible. As a result I tend to avidly read anything from the scene…

This week, there was a great podcast from Bridgewater – where Joanna Alpert, Bridgewater’s China manager based in Shanghai. Listening to her and others, it’s clear China has changed course. The economic pain of lockdown was vastly exceeding the medical benefits – with an increasing realisation the longer China hesitated, the deeper the damage would go. Xi made the pragmatic stability call – reopen the economy fully and pay the cost of inadequate vaccinations.

Now, the first most destructive wave of Covid has already sliced through China, the effects were considerable, but not perhaps as bad a feared. Now the economy is finally reopening with 2 bln Chinese journeys for Lunar New Year. Alpert makes the point the new government stimuli are all aimed at boosting consumption. But encouraging the population to spend now on consumption, when the demographic timebomb of an aging population requires pension savings to increase – they could be almost exclusive!

There have been a host of other fascinating analyst articles in recent weeks as China reopens, and its now possible to form some views on where the economy may be headed. I’m pretty sure it won’t be what we expected just a year ago when we couldn’t help but wonder if we’d have war in Ukraine together with an Invasion of Taiwan. It’s time for a reassessment of China, and its place in markets.

The questions we want answered include: How much will China stimulate global growth? Are we right to be fearful of a resurgent China’s geopolitical ambitions? How does China weigh its economic needs vs the global economy? Is it time to reinvest? And the big one – How sustainable is the Chinese economic model in the face of economic reality, demographics, and changing terms of trade?

But to start, are we right to fear China? Maybe we’re making a fundamental mistake when we think of China as a monolithic state controlled by, and run solely for the benefit of, the Chinese Communist Party. A better way to consider China may be in terms of a single overriding imperative: “Maintaining Social Stability”.

A quick glance at the modern history of China, humbled by the west from the 1840s, struggles with poverty, civil war, social chaos and party conflict – explains why. It’s clear the CCP has achieved an incredible “leap-forward” in terms of where Chinese society is today in just a few decades. It’s happened because of the party enforcing stability through a pact with the populous; let us rule and you will prosper. It’s worked – thus far.

In the 1700s the Chinese economy may have accounted for over 40% of global GDP. It was a stable, organised agrarian and industrial economy producing goods for export around the globe. China famously didn’t want anything in return – western goods being considered inferior – except silver. The strength of the internal economy was its scale. But sclerotic bureaucracy, inertia, unrest, inflation (from silver!), and the insidious taint of corruption were increasingly in evidence. (Lessons to remind ourselves of here in the West.) It became a crisis in the 1800s as pushy Westerners started importing opium, and the rest as they say… is history.

Today, China’s transition from superpower to economic trainwreck and back to superpower is unparalleled.

Over the past year I’m pretty sure the Central Committee will have watched the Russian’s quagmire themselves in Ukraine with considerable shock and made some telling calculations. The tactical and strategic doctrines of the People’s Army and weaponry are too similar to the Red Army to have given them any comfort. Recent wargames at CSIS showed China lost – although it cost the American’s hundreds of planes and 3 carriers. The CCP will be just as concerned at the economic effects of an invasion on the economy. The result the likelihood of War in South East Asia has dialed down a few notches. China has the problem of continuing the modernisation of its forces at a time when available manpower will be falling – another lesson to learn from Russia. The appetite for patriotic war may diminish significantly.

As a reaction to Covid and the realisation they aren’t yet ready, what are seeing right now in China is quite extraordinary – the dramatic, sudden and surprising reopening of the economy, and a race for growth. Pump up the economy with rate cuts, remove lending and mortgage restrictions, reopen everything, hope that Covid death rates don’t crush support. To all intents and purposes China is now in full reflation mode. Some observers even think China is abandoning long-term climate change goals in return for short-term growth.

Why?

Rising youth unemployment on Covid shutdowns and lost contracts with the West doen’t help stability. The property dream has stalled for many workers. There is recurrent conflict between regional governments and the populace over land grabs. My take is President Xi and the CCP has paid attention to underlying shifts in sentiment and is responding to the economic damage and repair the Iron-Rice-Bowl. Reopening the economy and fiscal boost will be probably be accompanied by another anti-corruption campaign.

The plan is to recreate prosperity. That’s hardly surprising – under the iron-rice-bowl concept the Chinese leadership has developed an acute ear to what the populace is thinking – they listen and respond, aware the social stability of China depends on party leading the populace to wealth and prosperity. The focus in China now will be to boost domestic consumption.

The need to push for growth has been reinforced by the consequences of long-term policy mistakes. Xi took a power-politics risk by demanding a third term in power and likely emperor for life status. The Party is only popular if everyone is getting rich – if not the inequalities in the system could quickly create instability. The risk of instability remains not insignificant.

The obvious policy mistake was population control through the one-child policy of the last century – the result is looming twin long-term demographic crises of an aging and male-skewed population. The fact China is no longer the most populous economy – overtaken by India – leads many analysts believe China got old before it got rich. The shortage of women will create all kinds of consequential tensions.

In just a few decades the economy will have significantly shrunk unless it becomes more productive. The plan is for China to invent and innovate its own tech to do so, but that’s a long shot – especially after the State effectively nationalised Tech innovation by quashing tech entrepreneurs over the last few years. The big China Tech firms may be standing up again, but will they push with the same vigour for market share – aware of the potential of the state to act again?

There will likely be compromise – including trying to reverse a growing trend to disinvest in China. The Middle Kingdom will probably need to embrace free markets and deal with the capitalist wealth to increase productivity to an ever greater and fairer degree to build the automation and tech base it will need in an economy needing substantial productivity gains as the demographic axe falls. Isolationism didn’t work for China centuries ago – and won’t work in a still globally connected market. China is finding itself shunted towards the periphery – which is another reason it will try to re-engage.

China’s ham-fisted attempts to develop its own trade through Belt & Road projects, while trying to buy Africa through debt politics has seen lacklustre results. Today, it is going out with a more friendly face. But, more and more companies are pulling production out of China and are looking to offshore it elsewhere – India and South East Asia – compounding the problem of creating internal growth as export demand falls.

The big news this week – the fraud allegations made by short-seller Hindenburg against Indian billionaire Gautam Adani’s conglomerate – may be a small boon to China. With US firms planning to offshore significant amounts of business from China to India, it’s a reminder of just how opaque and nationalist Indian business can be. (That said, India is one of my big themes over the next decade.)

I haven’t reached any firm conclusions on China yet, but it strikes me China needs markets more than ever – and that’s worth thinking about. It’s going to be fascinating to see how and where China plays out.. For the meantime.. go with the flow..

Five Things To Read This Morning

WSJ – Growth was less than Advertised, Better Than Feared

FT – Adani sell-off hits $42 bln after short-seller targets group

WSJ – Russia’s War on Ukraine Changed Global Oil Trade. Here is what it looks like now.

Bberg – Hunt to Rule Out Tax Cuts While Touting UK’s Brexit Potential

Bberg – Oil Gains as China Optimism Outweighs Slowdown Concerns

Shard Litebite Podcast – In Gold We Trust

Out of time, back to the day job and have a great weekend. Porridge may be sporadically timed next week as I’m travelling on business.

Bill Blain

Strategist Shard