‘Carnage in China's financial markets signals the beginning of a new era as the government puts socialism before shareholders, and regulatory changes rip apart the old playbook,’ writes Reuters’ Tom Westbrook.
- ‘According to some analysts, it is the most significant philosophical shift since former leader Deng Xiaoping set development as the ultimate priority 40 years ago.’
The analysts are right.
- But, wow, are they late.
Just as he has remade Chinese politics, the Party, great swaths of society, and international relations in his vision, Xi Jinping is now remaking China's economy - and he has been at it for a long time.
- Far long enough for institutional investors to have incorporated the impact of his vision into their investment strategies.
We are no doubt paying it belated attention because of the ‘carnage.’
- But had we been paying attention earlier – and trying to understand China’s goals from its points of view - I’ll bet a lot of the carnage could have been avoided.
What follows here is a brief outline of ways to understand China’s points of view.
- Then, as the song says, ‘We won’t get fooled again.’
1 | ‘Nobody Saw This Coming.’
‘A list of Chinese technology companies that have fallen foul of regulators would look almost identical to a list of tech success stories,’ writes The Editorial Board of the Financial Times. ‘Fears of a broader crackdown on private enterprise are now mounting.’
- ‘The question is whether the Chinese government simply does not care about appetites to invest and has calculated that international finance is no longer helpful to development, or is actively trying to dissuade companies from listing overseas.’
- ‘In China Doesn’t Care How Much Money You Lose,’ [excerpts below] Shuli Ren of Bloomberg gets us a little closer to the right one:
‘Does Beijing not care how much money foreign investors have lost? Does the government really want to close China Inc.’s access to the deep pool of global capital?’
- ‘The short answer is, no, the government doesn’t care.’
- ‘But it’s not that simple. Beijing is pursuing other goals:’
‘Other goals’? Huh?
- To understand what is happening, we can’t keep asking the wrong question: ‘Why, oh why, is Beijing doing this to us?’
That reflects a fallacy summed up in the smart quip: ‘China does not manage its economy to suit Wall Street analysts.’ (This should be posted above the desk of every institutional investor.)
- (You could substitute ‘multi-national corporations’ for ‘Wall Street analysts’ and be equally correct. Post that above the CEOs’ desks too.)
Not being aware of Beijing’s ‘other goals,’ leads to comments like this from Steve Rattner of Willett Advisors during a Bloomberg interview:
- ‘I don't think anybody saw any of this coming.’
- ‘People talked about issues with political crackdowns and the Uighurs and Hong Kong and all that.’
- ‘But what's going on now? I can't recall any China watcher really identifying very clearly for us before it happened.’
- Really, Steve, you’re listening to the wrong China watchers.
Instead, the Editorial Board of The Wall Street Journal put it best in ‘Wall Street Gets a Chinese Education’:
- ‘The big surprise from the slump in Chinese company stocks is that people are claiming to be surprised.’
‘President Xi Jinping has made plain for years that he intends to bring ever greater swathes of China’s private economy under the state’s control.
- ‘Guess what, Wall Street: He meant it.’
What is it that ‘Xi Jinping has made ‘plain for years’?
- A lot more than bringing ‘greater swathes of China’s private economy under the state’s control’ – although he is doing that too.
To understand all that Mr. Xi is up to, we have to peel back a few layers, starting with what’s behind the current set of reforms and then see how these fit into Mr. Xi’s overarching vision for China's economy.
- By understanding these, both institutional investors and CEOs are less likely to be surprised again when they suddenly realize too late: ‘He meant it.’
2 | The ‘Four Pillars’
Peeling back the first layer, let’s complete Shuli Ren’s thought: ‘But it’s not that simple. Beijing is pursuing other goals.’ Those goals:
- ‘Reining in the power of its tech titans and boosting startups;’
- ‘Protecting social equality; and’
- ‘Making sure the cost of living in cities isn’t so high that families aren’t willing to have children.’
‘And Beijing is suspicious of companies that are skilled at raising capital overseas—beyond its watchful eye.’
In ‘How Xi’s Four Pillars of Regulation Will Reshape China’s Big Tech,’ [excerpts below] Ms. Ren explains further:
- ‘Broadly, Beijing is concerned about four pillars of stability: banking, anti-trust regulation, data security and social equality.’
‘All of Beijing’s major interventions reflect these concerns:’
- ‘The last-minute scuttling of fintech giant Ant Group Co.’s $34 billion initial public offering last November because of its potential disruption of banking;’
- ‘Alibaba Group Holding’s record $2.8 billion fine for monopolistic business in April; and’
- ‘The cybersecurity watchdog’s investigation into DiDi Global Inc. immediately after its $4.4 billion IPO this month.’
‘Going forward, investors need to realize the four pillars are part of President Xi Jinping’s vision to ensure another hundred years for the ruling Communist Party, which just celebrated its centenary.’
Going deeper: ‘ The messaging in the months running up to the Party's July 1 centenary was also unequivocal,’ writes Reuters’ Tom Westbrook [excerpts below]:
- ‘ "Common prosperity" is the over-riding long-term goal, Xi said early this year, and China's development should be centred on people's expectations of better lives, urban-rural gaps and income gaps.’
As Ms. Ren notes: ‘President Xi Jinping doesn’t care if stock investors, many of them foreigners, lose billions of dollars.’
- ‘He knows that China’s middle class will have his back. They like these regulatory crackdowns.’
‘The Ministry of Education’s for-profit tutoring ban, for example, is a crowd-pleaser.’
- ‘In the Chinese society, a family’s wealth alone already gives its offspring a natural edge, but the middle class does not enjoy seeing that edge amplified through an army of tutors.’
This is a vintage example of how true is the adage:
- ‘China does not manage its economy to suit Wall Street analysts.’
3 | But Wait. There’s More.
By peeling back the next layer, we see that the current reforms are in turn part of a larger restructuring of the Chinese economy.
- Consider just two examples: ‘Made in China 2025’ and the ‘Dual Circulation Strategy.’
‘Made in China 2025’. Dan Wang of Dragonomics in ‘China’s Sputnik Moment?’ in Foreign Affairs notes:
- ‘The centerpiece of the Chinese state’s industrial planning apparatus is the “Made in China 2025” plan.’
- ‘Announced in 2015, the plan highlights ten high-tech industry segments in which Chinese firms should make breakthroughs, and it sets self-sufficiency targets in striking detail.’
- ‘Such specific targets bring to mind the days of China’s planned economy, when the state micromanaged all industrial output.’
And this from Mr. Wang’s blog written in 2019 [note to Mr. Rattner's China watchers: That’s 2019, for goodness sakes!]:
- ‘While promoting the status of science and technology with one hand, the Chinese government has with its other hand reined in the activities of consumer internet companies.’
‘The “tech” giants are highly-capable companies that print cash.’
- ‘But they’re barely engaged in the creation of intellectual property, excelling instead on business-model innovation and the exploitation of network effects.’
‘It’s become apparent in the last few months that the Chinese leadership has moved towards the view that hard tech is more valuable than products that take us more deeply into the digital world.’
- ‘Xi declared this year that while digitization is important, “we must recognize the fundamental importance of the real economy… and never deindustrialize.” ’
‘This expression preceded the passage of securities and antitrust regulations, thus also pummeling finance, which along with tech make up the most glamorous sectors today.’
‘The optimistic scenario is that these actions compress the wage and status premia of the internet and finance sectors, such that we’ll see fewer CVs that read:’
- ‘ “BS Microelectronics, Peking; software engineer, Airbnb” or “PhD Applied Mathematics, Princeton; VP, Citibank.” ’
As Mr. Browne puts it: ‘Chinese entrepreneurs are expected to get with the program or get out of the way.’
- ‘That means focusing on the next wave of growth—to be led by industrial automation, smart cities and the “Internet of Things—rather than extracting oversized profits from consumers.’
And in addition, Beijing hopes that by souring investor interest – both domestic and foreign – in consumer internet companies, he will be able to redirect that capital to the ‘hard tech’ companies represented by the industries being championed in ‘Made in China 2025.’
‘Dual Circulation’. Then there’s the ‘Dual Circulation Strategy.’ As Jude Blanchette and Andrew Poll of the Center for Strategic & International Studies in ‘Dual Circulation and China’s New Hedged Integration Strategy’ explain:
- ‘The strategy, announced in 2019, envisions a new balance away from global integration (the first circulation) and toward increased domestic reliance (the second circulation).’
‘One key element of the DCS is to focus on both the strengths and weaknesses of the domestic economy—consolidating the former and addressing the latter in order to improve economic resiliency and self-sufficiency.’
- ‘That means further stoking demand from China’s domestic economy and gearing Chinese producers to meet that demand with expanded output for the domestic market rather than for export—all while finding ways to reduce reliance on external inputs in key areas, including energy, technology, and food.’
To ‘stoke demand from the domestic market,’ consumers have to buy more.
- To buy more they need to have more money in their pockets.
Putting it there is one aim of the current reforms. For example:
- ‘The government posted notices that online food platforms must ensure that delivery staff earn at least the local minimum income.’ [That’s because they are woefully underpaid and hence aren’t doing their share to support Dual Circulation.]
- With that, ‘Online food delivery giant Meituan’s share price dived 14%, its worst on record, wiping out about $30 billion market cap.’
- Less money in investors pockets but more in gig workers’.
And as Mr. Westbrook writes:
- ‘Housing, medical and education costs were the "three big mountains" suffocating Chinese families and crowding out their consumption, said Yuan Yuwei of Olympus Hedge Fund Investments.’
- The current reforms have already targeted the education costs of online tutoring. Property is generally expected to be next. Medical?…stand by.
- So ditto investors’ versus the general public’s pockets.
4 | ‘The Third Revolution’
‘According to some analysts,’ writes Mr. Westbrook, ‘the current spate of reforms is:'
- ‘The most significant philosophical shift since former leader Deng Xiaoping set development as the ultimate priority 40 years ago.’
True. But this realization comes way late. There is a final layer that takes us to the core that long precedes it.
- And that core is best described by the title of a book by Elizabeth Economy of the Council on Foreign Relations: The Third Revolution: Xi Jinping and the New Chinese State.
Dr. Economy contends that China in the communist era has undergone three revolutions.
- The first, Mao Zedong and the founding in 1949 of a socialist state under the rule of the Chinese Communist Party (CCP) but more directly of Mao himself.
- The second, Deng Xiaoping and the economic opening of China in the 1970s under the banner of ‘Socialism with Chinese Characteristics.’
- And the third, Xi Jinping.
Sensing that the CCP was losing its grip and society going its own way, the Party elders selected a cadre, without a faction of his own, to bring the Party and the Chinese people to heel.
- They got more than they bargained for.
Unbeknownst to them, the new General Secretary Xi Jinping had a sweeping vision to remake China and an unwavering will to realize it.
- He has made himself the most powerful Chinese leader since Mao.
- He has re-established the Party’s dominance, making real the Mao era mantra and reaffirmed by the National People’s Congress declares: ‘Party, government, military, civilian, and academic; east, west, south, north, and center, the Party leads everything.’
- He has reshaped China’s international relations by sanctioning ‘wolf warrior’ diplomacy, annexing great swathes of the South China Sea, participating in the escalation of tensions between China and the U.S., and generally challenging the western liberal world order.
- And so much more.
His latest target: Remaking China’s economy to match his vision.
- And it has had the bullseye on its back way before the current reforms, as ‘Made in China 2025’ and the ‘Dual Circulation Strategy’ show.
This is the basic framework upon which we should situate the current reforms.
5 | ‘Whack-a-Mole’
It’s still early for comprehensive analyses of what’s happening these days. So in addition to reading media coverage, I’ve been watching a lot of Bloomberg and CNBC interviews.
- Given the foregoing discussion, you may rightly assume that I agree with the WSJ: ‘The big surprise from the slump in Chinese company stocks is that people are claiming to be surprised.’
Among the interviews I watched, one in particular astonished me (and made me despair for the poor souls who gave this guy their money to manage). Here is Brendan Ahern of KraneShares in a CNBC video interview.
- ‘The regulation feels as if it’s being done on almost an ad hoc basis, leading to almost a whack-a-mole type of situation, that whenever you feel like you finally got something done with, something else pops up.’
Ad hoc? Brendan, you have not been paying attention.
- As we have seen, Xi hasn’t built anything like a whack-a-mole game.
Instead, he is systematically, step-by-step, working to realize his vision of how he wants the Chinese economy, or especially specific key sectors, to behave.
- After remaking China’s politics, Party-state relations, a good chunk of society, and international affairs to his liking, Mr. Xi has turned to the economy.
He is remaking the economy with initiatives like ‘Made in China 2025’ and the ‘Dual Circulation Strategy’ aimed at strengthening the economy (and the Party’s iron fist on China), shoring up external vulnerabilities, and addressing domestic issues as domestic inequality and the income gap. And he is doing so much more.
- In this light, the current reforms are just a part - and just the latest part.
With all this in mind, consider again Shuli Ren’s comment:
- ‘Does Beijing not care how much money foreign investors have lost? Does the government really want to close China Inc.’s access to the deep pool of global capital?
- ‘The short answer is, no, the government doesn’t care.’
- ‘But it’s not that simple. Beijing is pursuing other goals.’
Until we make Beijing’s ‘other goals’ the focus of analysis - whether for investment or business or government policy - and embrace the adage that 'China does not manage its economy to suit Wall Street analysts (or multi-national corporations), Mr. Xi will continue to surprise us.
- And we will always and unnecessarily be a few steps behind.
6 | Forget The WSJ. Read Qiu Shi.
What is the best way to understand Beijing’s other goals?
- Here’s Dan Wong again from his blog:
‘This year, I read every issue of Qiushi (translation: Seeking Truth), the party’s flagship theory journal, whose core task is to spell out the evolving idea of socialism with Chinese characteristics.’
- ‘For those not familiar, Qiushi reads like a cross between the New Yorker and the Federal Register.’
‘Propaganda [ala Qiu Shi] might not matter to you, but it matters to the party. The leadership considers propaganda to be the “lifeblood” of the party state.’
- ‘Propaganda work is considered so powerful that the person in charge must be only a functionary. The head of propaganda always has a seat on the Politburo.’
‘Propaganda is key to understanding the party, since it governs not in itself, but in symbiosis with state institutions.’
- ‘For the most part, the party’s role can be boiled down to two items: inspiration, by setting the ideological direction, and control, through its power to select personnel.’
And as Andrew Browne writes, ‘When politics are in command, the markets-based models Western financiers use to calculate China risk aren’t much use.'
- ‘Eric X. Li, a Shanghai-based venture capitalist, says he adopted his entire investment thesis from recent copies of Qiu Shi—literally “Seeking Truth”—the Chinese Communist Party’s leading theoretical journal.’
‘Li’s advice: “We should read ‘Qiu Shi’ seriously, roll up our sleeves and work hard.” ’
- Good advice indeed. Here’s the link to the English online edition to get you started.
And, oh yes: Work hard!