By Felix Fok*
China has always had its doubters, even though its economic achievement is indisputable. In four decades, close to 800 million people have been lifted out of poverty in China1. The size of the middle class and the quality of infrastructure have all seen significant development, judging by GDP per capita metrics and on-the-ground observations. It has served investors well to keep an open mind on single-party, big governments, even if this is not the orthodoxy in the western world.
While many have questioned the rise in debt in the country and the recent downturn in property, the Chinese government can handle a financial crisis given its control over critical financial institutions and capital flows. There is a well-trodden path to managing bad debts (as the GFC and Greece have reminded us). A financial crisis would be painful but likely manageable.
Neither should one be overly concerned by Chinese economic growth this quarter. Prosperity measured by medium-term nominal GDP growth (in US dollar) matters, short term less so. China is a centrally planned economy that spends to maintain social stability and drive growth2. Government directed spending, such as infrastructure projects, can be ramped up at some point to lift activity to be respectably close to the target, which is said to be around 5.5% this year. If a problem can be solved with money, it is not a problem.
The issue is political.
A China solely driven by finance and what’s good for its pockets would be straightforward for investors to back; free trade would reign, and globalization would continue to benefit capitalists and consumers. Sadly, this is increasingly not the case.
The top two powers in the world grew further apart during the US-China trade war (2018).
Trade tariffs and President Trump’s ‘America First’ mantra further pushed the US towards a containment (rather than engagement) strategy on China. The tit-for-tat meant that the US and China are now more likely to take opposing views across a range of issues, an overt rivalry.
Meanwhile, President Xi Jinping managed to remove the two-term (10 year) limit for the country’s top leadership post, following an anti-corruption drive that consolidated his power base. President Xi had strong, genuine support amidst rising nationalism as China regained its global status 150 years after the Opium Wars and the fall of the Qing Dynasty. There is no successor to Xi in the party line-up. Emperor Xi is ‘In’; collective leadership and dissent are ‘Out’.
Enter Omicron, an unexpected test of Beijing’s domestic narrative and the prioritization of politics over economics. Early in the pandemic, the suppression of the initial outbreak by lockdown in Wuhan, China, was rightly applauded as a victory for sacrificing individual freedoms for the greater good. At the same time, the US fumbled badly, with deaths per population far exceeding other first world countries in 2020. The Chinese media duly ran nationalistic videos of nurses, doctors, and Wuhan citizens emerging as national heroes.
The ‘Zero COVID’ policy became engrained. Officials made the most of narratives on ‘prioritizing life’ and refusing to ‘lie flat/idle’, a quip aimed at the West that neither had the ability nor willingness to keep COVID out and save their people. For most of 2020-2021, citizens in China lived as usual, and the nation’s pride grew for having defeated the virus while other countries paid a heavy price. But COVID evolved.
The Omicron variant is more infectious but less severe than earlier strains3, characteristics that potentially elevate the cost of lockdowns. When NZ, Australia and Singapore pivoted to ‘living with the virus’, China doubled down on ‘Zero’ and later ‘Dynamic Zero’. Instead of following the science, China defaulted to the same strategy (go hard [lockdown], go early, compulsory mass testing) that aligns with its political narrative.
The current Omicron outbreak in Shanghai suggests that some residents, who have been in lockdown for nearly a month, think the ‘cure’ – in the form of hard lockdowns, is worse than the disease itself4 as restrictions have lasted much longer than expected. This dissent has been suppressed domestically but seems understandable to those who know lockdowns.
But since so much has been made of defeating the virus and how China has had fewer deaths than the West (China’s death per one million population is 4 vs. NZ 143 vs. US 3,051), it solidified its health policy, making it politically difficult to switch to ‘living with the virus’ (where the US is). Whereas a vaccine can inoculate the masses from the infection, how do you save a nation from wounded pride?
President Xi reinforcing efforts to tackle Omicron and the lack of a political off-ramp to change tack opens the prospect of rolling (hard) lockdowns which may alter medium-term growth expectations and supply chains and cause additional volatility in inflation. Also, repercussions extend beyond its borders as China benefits from cheap energy imports from Russia. Its tacit role in helping Russia blunt the impact of international sanctions already attracts scrutiny. A weaker economy will make it harder for China to resist Russian requests.
I am not known as a China bear and would happily be wrong on the above musings. Omicron could fade, and the outbreaks become controlled. China might get mRNA vaccines and avoid the risk of overwhelming its health system and thereby justify a softer approach (although not having the Pfizer vaccine approved in China is already an indication of the political issue I have tried to highlight). But the implications are far-ranging. Global markets invariably have some exposure to the Chinese economy. Our funds have reduced direct Chinese holdings and require a higher return on such holdings than previously.
*Felix Fok is the Portfolio Manager of the Global Equity Fund at Milford Asset Management. This article first appeared here and is used with permission.
[1] https://www.worldbank.org/en/news/press-release/2022/04/01/lifting-800-million-people-out-of-poverty-new-report-looks-at-lessons-from-china-s-experience
[2] https://carnegieendowment.org/chinafinancialmarkets/78138
[3] https://fortune.com/2022/04/08/omicron-symptoms-covid-19-different-delta-lancet-study-uk/
[4] https://www.scmp.com/news/china/politics/article/3175299/voice-april-shanghai-covid-19-protest-video-testing-censors
20 Comments
It's hard believing anything you read these days, but it seems like there's limits to autocratic governing that aren't compatible with continuous global trade. If the CCP wasn't so hamstrung by having to never be wrong this would all be a non issue.
This decade will be a good time to be a manufacturing nation that isn't China.
This article, although written from the narrow perspective of an investment analyst, reinforces the idea that we live in a world that is increasingly unstable with huge uncertainties. The political paths forward in that globalised and resource-constrained world world are challenging to identify.
KeithW
They were a golden period. They started with a still-almost-full stock of planetary resources and only two-point-something billion inhabitants.
We need to plot the trends; ever more people demanding ever-more resources each, vs ever-less planet. Conflict is inevitable, meaning so are borders. And borders spell a reversal of globalism (as if that wasn't blatantly obvious already; I'd reckon the peak of globalism as the Mike Moore/Gatt era; a quarter-century gone).
Good article, provokes thought and rationally laid-out, but I'd be questioning the very nature of 'investment', round about now.
Political paths forward. Hazard to suggest for the CCP & China a great pathway has opened for them to the west. That is via a greatly weakened Russia economically, militarily and potentially politically. Russia must greatly increase its reliance on China both as a market for energy, minerals, grain etc and hence China will become the dominant partner. Something of a role reversal.
The challenge is to identify alternative paths. New Zealand's economic development of the last 20 years was driven by a natural alignment between what China could produce and what it therefore wanted to buy and sell, and what New Zealand could produce and wanted to therefore buy and sell. At no time did we turn away from alternative paths. We explored India, South East Asia, and South America. We were already engaged with Japan but struggled to further develop linkages in the context of the relative need for each other. I have had work assignments on every continent of the world and there is nothing to compare to the natural trading alignment that exists between New Zealand and China. Note that I am talking about natural trading alignment, not political relationships. In terms of investment, our investment in China has been tiny. Basically, they come to us and buy our products which we then load on ships and wave goodbye to.
KeithW
In terms of investment, our investment in China has been tiny. Basically, they come to us and buy our products which we then load on ships and wave goodbye to.
Exactly:
In such a torrential stream where crosscurrents are foaming and weltering, what probably unnerves the Biden Administration most could be the talk that Chinese President Xi Jinping may be planning to visit Saudi Arabia, amidst persistent reports recently that Riyadh and Beijing are in talks to price some of the Gulf nation’s oil sales in yuan rather than dollars, which would indeed mark a profound shift for the oil market and help advance China’s efforts to convince more countries and international investors to transact in its currency.
The Saudi explanation for the shift to the yuan is that the kingdom could use part of new currency revenues to pay Chinese contractors involved in mega projects within the kingdom domestically, which would reduce the risks associated with the capital controls Beijing imposes on its currency. But, for Washington, that means certain sensitive Saudi-China transactions in yuan do not appear in the rearview mirror of the SWIFT messaging infrastructure, making transaction monitoring unviable.
There are persistent US reports that with Chinese support, Saudi Arabia may be constructing a new uranium processing facility near Al Ula to enhance its pursuit of nuclear technology. Saudi Arabia’s generous $8 billion in financial support for Pakistan, unveiled this week, will almost certainly raise hiccups in Washington.
Saudi Arabia is a central pillar of China’s Belt and Road infrastructure initiative and ranks in the top three countries globally for Chinese construction projects, according to the China Global Investment Tracker, run by the American Enterprise Institute. Suffice to say, the CIA chief’s call could not have been for a friendly chat with Prince Mohammad. Link
Say what you will about China but their infrastructure and roading is nothing other than mind blowing. If all you listen to is the MSM then you are going to think that China is all bad and they all live in a tin shack. They have some achievements that we can only dream of in New Zealand that make us look down right pathetic. No I don't want to go and live there but you have to give credit where credit is due.
No doubt China can built things of decent quality for a price, but they're also masters of pumping out superficially impressive infrastructure and buildings of dubious quality.
As for the rail, it sounds like they spent a couple of trillion dollars on fast trains that lose money hand over first. Not that rail is a money winner, but it'll be interesting if China's rapid rail network retains its size and composition long term.
Which is actually find for them, given their demographic trajectory they just won't need the housing or infrastructure in coming decades.
China is in a debt trap though, they build a lot of capital intensive projects to boost GDP but very few of those projects are projected to earn an economic return greater than the cost of capital. They are painting themselves into a corner quite rapidly.
" In four decades, close to 800 million people have been lifted out of poverty in China1"
Communism, under Chaiman Mao, made the chinese very poor
"While many have questioned the rise in debt in the country and the recent downturn in property, the Chinese government can handle a financial crisis given its control over critical financial institutions and capital flows."
Therein lies the critical issue, the CCP governance is young and new to capitalism. The property market is but the tip of an iceberg.
Wrong John...it's not the Chinese people that you should express concern about...but rather the political machinations of their leaders. But there can be no doubt about their achievements in the last 40 years that you have distrusted them...800 million plus pulled out of abject poverty and achievements in infrastructure and technology that simply are astonishing, and their adaptability in managing such a massive country. Yes they stumble and struggle but in all of it we have to remember that there is more that 3000 years of culture behind the Chinese civilisation and that does set things up to be different.
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