Where is China going with its new economy?

Blain’s Morning Porridge Oct 25th 2022 –  Where is China going with its new economy?

“The vast Pacific Ocean has ample space for China and the United States….”

This Morning: When the fact change, change strategy. The enthronement of Xi Jinping represents such a moment – and confirms the big theme for coming decades: The Middle Kingdom vs the West.

Compare and contrast two very different economies:

• One is a free market economy struggling with chaotic politics triggering market instability, price volatility and rising uncertainty.
• The other has, arguably, the most stable politics on the planet, but is also seeing its markets tumble and currency fall as the decisions of stable government panic investors.

Both illustrate the critical importance investors ascribe to “politics” as a factor of a nation’s “Virtuous Sovereign Trinity” in setting its likely economic success.

Yet, the UK and China are very different stories:

• Markets just brought down a Conservative government because it was seen as naïve, ideologically driven, and deaf to the negative consequences for the economy and UK growth it was likely to trigger.
• China stocks and the Renminbi crashed yesterday. The Chinese Communist Party is not in the least concerned by what markets think after it enthroned Xi Jinping as God-Emperor. It is studiously ignoring a major sell-off by global investors who now see China trading future growth for the security of the party. The collapse in Hong Kong and US listed Chinese shares yesterday didn’t make the front pages of any the Chinese papers according to Bloomberg. This year foreign China stocks are down between 1/3 and 1/2.

Xi talks about engagement with the global economy, but his Middle Kingdom is now focused on internal self-sufficiency, innovating its own tech base, and effectively putting the economy on a footing for a showdown with the USA. The key appointments are on spending and further modernising reforms to its armed forces. Covid restrictions have caused the economy to tank, but come with the added advantage of effectively closing out external visitors – meaning we have very little real on-the-ground intelligence on the true state of the economy.

For a really good insight into today’s Covid China reality, let me suggest this interview with traveller Scott Kennedy on a recent trip where it took him 17 days to reach Beijing: US Analyst Says Beijing is “Pyongyang-like” Under China’s Covid Zero”.

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Harry Hindsight is the greatest trader I ever met. I wish I’d asked him before I piled into China years ago. I judged it a cheap opportunity to get into the globe’s economic powerhouse, without understanding just how the economy and politics really worked. Big and costly mistake. I’ve learnt some lessons.

Timing is everything. I bought well before the leadership of the Chinese Communist Party (CCP) decided to crush entrepreneurs and their dangerous popularity, by hammering down sticky-out-nails and taking tech companies into de facto government control. I put my money down pre-Covid, before Hong Kong was effectively annexed, and ahead of the growing tension and looming faceoff with Taiwan.

I made my investment decision based on the thesis China was on the verge of fundamental change and global engagement. I expected its’ explosive growth to continue as it blossomed into a relatively open and wealthy Asian consumer society under a security conscious regime.

Instead, under Xi it’s becoming a closed autocracy – the home of surveillance communism; successfully monitoring every single aspect of citizen’s lives. As a result, the party can worry less about keeping workers happy.

One fascinating insight in the Kennedy interview with Bloomberg was just how invidious social control has become since his last visit in 2019: “you can’t be invisible and anonymous in China anymore, because you simply cannot physically move anywhere without being tested to get a green code on your phone, and then scanning your phone everywhere. That is a dominant part of people’s lives.”

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Following his elevation to the Jade Throne, President for Life, the God-Emperor Xi now appears omnipotent. He was able to delay crashing GDP numbers that might previously caused wobbles at his coronation. Party officials were desperately trying not to see former President Hu Jintao being bundled out the Hall of the People – it was a clear sign of Xi’s absolutism. It was a telling moment.

Five years ago I was writing how anything less than 7% growth would be a disaster for China. The number was required to ensure the “Iron Rice Bowl” compact between the party retaining power in return for providing the people with jobs and a rising standard of living. That’s changed. Using the social control tools of Surveillance Communism, tested through the convenience of Covid Lockdowns, the CCP can largely dispense with the need to worry about the workers – it knows where they are.

All internal dissent has been crushed. Xi has consolidated his position. The entire CCP apparatus is his. He was wiped out opposition from industry, rival party princelings, while neutralising the faction of former president Jiang Zehmin. The only way to patronage now is through the Xi Gang. He has complete and absolute control. He is surrounded by yes-men who owe their positions to his patronage. Hmm… that seldom works well.

Growth, after Covid Lockdowns, is sub 4%, the property valuation mythos is imploding and the reality is probably a more brutal economic slowdown than even the crashing domestic stock market implies. Chinese state data was always suspect, but we know less about the economic reality within China than ever.

Trying to figure out where China goes next is a tough one. There are plenty of reasons to suspect the worse, but if you’d looked at China 50 years ago there were very few reasons to expect it would become the World’s largest economy and take so many people out of rural poverty. Will it surprise us again, or does Xi represent the end of the line for China’s economic miracle?

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Perhaps the best way to consider China in relation to the economic history of other autocracies. There is no doubt the policy of encouraging private industry within a matrix defined by the state worked extraordinarily well for China – they are, after all, a nation of traders if not a trading nation! They beat the west for 20 years through being “cheapest to produce”, undercutting western production by exporting price deflation on every conceivable manufactured item.

But does China have the imagination, invention and innovative skills to shift its economy from being a price taker at the lowest level to becoming a price setter exporting new and unique goods and services? The jury is out on that one.

I suspect China will quickly discover its new Autocratic economy can’t deliver the innovation it requires. That requires uniting the nation in common cause – against a common enemy – which is why the Taiwan and anti-US rhetoric, a new Sino-cold-war looks nailed on.

All societies produce a mix of personalities to thrive. Which rise to the top determine how well the society fares. Ancient Rome is a template. Before the Empire was established under Augustus, individuals rose by their successful pursuit of “lustrum”. If a general won a new province of the empire, if a jurist was sufficiently skilled, or a politician exceptionally devious, they could rise to become Consul – de facto ruler of Rome. Until Augustus the Republic of Rome’s story was constant expansion of its borders. After Augustus, the Empire was about protecting the Emperor and defending his borders. Innovation, expansion and opportunities declined.

My chum, David Murrin, eco-historian and future-ologist, has defined the great codes embedded in history. His Five Stages of Empire looks at how wealth creation builds economies, while wealth distribution weakens the underlying economic system. What you win on roulette table you lose playing cards.

• During optimistic expansionary phases nations expand territory and influence, are clearly orientated towards the risks facing them, focus on growth and national infrastructure, build social cohesion, build national pride, a sense of duty and success follows.
• Contraction pessimistic phases follow as national power wanes, protectionism and closed borders become the norm, libertarian purpose and the supposed rights of the individual rather than society dominate politics, society fragments into the have and have notes, social discord rises, wealth inequality prevails.

Try applying the above broad-brush theory to any nation today – and it generally stands up. The crisis for the UK becomes obvious, as it does for the US.

But what is really surprising is where China could be on that list. Although its extremely unlikely libertarian politics will ever prevail in China – there isn’t that wide a gap between the right-wing dictatorship of the individual and Xi’s vision of autocracy and renewal of the Empire. It’s just that Xi has the tools to make it happen.

Or, as the demographers have pointed out, the consequences of single child policies have caused a massive shortage of women, and a crashing birthrate – leading to the adage “China has got old before it got rich”. China’s prospects of an-encompassing global trading empire based on Belt & Road infrastructure serving Chinese industry now looks tested.

Whatever happens, the risk is the new China becomes a destablising global issue – especially in Asia. So much for the Pacific pivot.

Five Things to Read This Morning

BBerg – Xi’s Power Grab Spurs Historic Market Rout as Foreigners Flee

FT – China Bulls hammered by stock rout as XI Jinping consolidates power

FT –  China’s wealthy activate escape plans as Xi Jinping extends rule

WSJ – China’s New Guard Bodes Change for Beijing’s Interaction With the West

Guardian – Xi Chooses Yes Men over Economic Growth in Politburo purge

Out of time, and back to the day job!

Bill Blain

Strategist – Shard Capital