Strangely of late, John Authers's headings to his Columns seem to praise Ratland. But when you read the contents, they are as devastating for the Ratland economy as those of, say, Ambrose Evans-Pritchard, among others. Here once again, Authers correctly focuses on the calamitous direction of Ratland (unsustainable fixed capital investment ) and warns us earnestly not to squander our money on Ratland.
Their resilience to the growing mutual hostility with the U.S. suggests the post-Covid recovery is for real.
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A Seismic Shift
China and the U.S. are ever more at loggerheads. Why doesn't it appear to matter? Chinese leaders are more assertive, and more openly critical of the U.S., than at any time since the death of Chairman Mao, while the U.S. has amped up anti-Chinese rhetoric to new heights. Beyond trade protectionism, the agenda now includes clamping down on U.S. investment into China, and shaming companies that do business there.
In a speech last week, the U.S. Attorney General William Barr made an outspoken attack on China’s communist rulers, and on U.S. firms that did business with them. The ultimate ambition of China’s leaders “isn’t to trade with the United States,” he said.
It is to raid the United States. If you were an American business leader, appeasing the PRC may bring short term rewards, but in the end and the PRC’s goal is to replace you. As a US Chamber of Commerce report put it, the belief by foreign companies that large financial investments and sharing of expertise and significant technology transfers would lead to an ever opening China market is being replaced by boardroom banter that win-win in China means China wins twice.
And he made it clear that he wanted people to punish companies with Chinese connections:
[T]he American people are more attuned than ever to the threat that the Chinese Communist Party poses, not only to our way of life, but to our very lives and livelihoods. And they will increasingly call out corporate appeasement.
As I’ve said before, the technology of ESG investing makes it easy for committed activists to force big public investors to shift money out of China quickly. This is serious stuff. And yet the speech attracted relatively little attention, I suspect, because anti-Chinese rhetoric has been rising for a while — and has been thoroughly reciprocated. After the U.K. made a U-turn and decided not to use Huawei Technologies Co. to build its 5G network, the Chinese ambassador said it would be “very difficult” for other businesses from the country “to have the confidence to have more investment” in the U.K. The foreign ministry in Beijing responded:
Does the UK want to maintain its independent status or be reduced to being a vassal of the United States, be the U.S.’s cats paw? The safety of Chinese investment in the UK is being greatly threatened.
Neither side appears to be bothering with diplomatic niceties any more. Meanwhile, China is also stepping up control of Hong Kong and pressing its territorial claims in the South China Sea. It’s what Dec Mullarkey, managing director of investment strategy of Sun Life Capital Management in Boston calls a “seismic shift.”
Yet it is having no perceptible effect on Chinese assets, or on investors’ willingness to invest there. No stock market has done better than China’s so far this year. And MSCI’s index of 100 companies in developed markets with the greatest exposure to China has now made up all the ground it had lost to the main MSCI World index since 2014:
Many of the weird trends in global markets during this remarkable year only make sense if we assume that investors are bracing for a fresh China-driven growth cycle. Much to many people’s surprise, China appears to be gearing up for exactly that. The following chart, from Andy Rothman of Matthews Asia, shows the trend in year-on-year growth for three critical macro variables — retail sales, fixed-asset investment, and the value-added by industry:
After a shocking fall as Covid-19 hit, the measures of industry are now back above their levels of last year. Retail sales, however, are lagging. If we look at online sales, it is obvious that this is driven by Covid — they have shot up so far this year, with their share of the total reaching a new high:
Plainly, Covid-19 is still getting in the way of the long-term plan to convert China into a truly consumer-driven economy, as physical activity is still very subdued. For another measure, the following chart from Bianco Research shows traffic on the Beijing and Shanghai subways. Neither is yet close to normal:
Rothman points to strong recoveries in sales of autos and homes to show that middle-class and wealthy consumers “have both sufficient money and enough confidence in the future to spend it.” But overall, sales at restaurants and bars remain 15.2% down from a year earlier. So Rothman, generally a strongly positive voice on China, says he expects economic activity still to be only 80% of normal by the end of this year. The final part of the recovery will have to wait until the global pandemic is brought under control.
This should be sobering for the rest of the world. As Mullarkey points out, China has a surveillance state, can “test and trace” as well as anyone, and yet its consumers are still reluctant to re-engage. The slowing in economic activity brought on by the pandemic isn’t caused just by governmental injunctions, in China or elsewhere. Voluntary changes in behavior are just as important.
With China entering and then leaving the pandemic first, we now have a taste of the economic policy that appears to work. Using a model characteristic over the last three decades, China has turned up the volume of credit, and this has sparked another revival led by industry and infrastructure projects. In classic style, this has sparked a resurgence in the constellation of assets that surround China, such as industrial metals and emerging markets. This chart, from BCA Research Inc., shows the clear links between China’s imports and the availability of financing:
If there were no great geopolitical reasons for concern, it might make sense to put money into Chinese industrial stocks. They have hugely underperformed over the last decade and have also lagged behind the main domestic stock index over the past year. But a recovery is afoot:
As this chart published at the beginning of this month by Oxford Economics makes clear, an increase in the credit impulse generally leads to old-line cyclical stocks outperforming:
Oxford Economics also suggests that a relatively safe way to invest is through developed market stocks with strong Chinese exposure. As we saw earlier, they have performed better of late, but their valuations relative to Chinese stocks still suggest they are much more of a bargain:
The trouble is that those developed market stocks only look so cheap because they are beginning to command a geopolitical discount.
In the long run, the potential problems for China’s economic model are legion. In the short run, it appears to be using a playbook that has worked several times before. The list of assets to buy when China is doing well is well established.
The question is how much discount to apply for the fact that the U.S. and the China are growing unmistakably more hostile to each other. There is an increasing risk of damaging economic sanctions, or a new trans-Pacific version of a Cold War in which two separate economic systems co-exist but interact ever less. It isn’t yet having much visible impact on markets, particularly in the U.S. That might be because there is an assumption that President Trump will be gone in six months, and that a President Biden would at least be more multilateralist in his attempts to contain China. It might also be because easy money from central banks trumps geopolitics.
But anyone who is feeling relaxed about U.S.-China relations would do well to read Barr’s words, both because of the truth they contain, and because the ferocity of his language is incompatible with maintaining any kind of constructive relations:
China is no longer hiding its strength nor biding its time. From the perspective of its communist rulers, China’s time has arrived. The People’s Republic of China is now engaged in an economic Blitzkrieg, an aggressive orchestrated whole of government indeed, whole of society campaign to seize the commanding heights of the global economy and to surpass the United States as the world’s preeminent technological superpower.For a hundred years, America was the world’s largest manufacturer allowing us to serve as the world’s arsenal of democracy. China overtook the United States in manufacturing output in 2010. The PRC is now the world’s arsenal of dictatorship.