Information is everywhere, Insight is priceless

When chip-maker Nvidia briefly hit the $2trn valuation in February it kindly seemed to bring the rest of the world with it. The S&P500 and Dow hit new highs; records were set and broken on Japan’s Nikkei and the Stoxx in poor beleaguered Europe. Chinese stocks even got a lift from the rising tide that benefited the rest of the financial universe. It won’t be enough to rekindle the fire in the economic dragon… it’s more of a tired wheeze.

Since its peak in 2021, Chinese stocks have shed some $7trn – around 35% of their value. For context, over the same period, US stocks have gained some 14%. And India – well I digress. In January alone, Chinese markets dropped $1.5trn. By February the country’s securities regulator had been canned and the government was stepping in to stabilize prices. That sort of intervention would be a red flag for any capitalist with enough money to matter, but in the Middle Kingdom the government’s hand on the tiller of the people’s finances is a comfort. Or at least it was when people thought the government knew what the hell it was doing.

And why not? In 2008, when property values in the capitalist world were crashing and taking hunks of the financial system with it, China endured a single downward blip in real estate prices. So naturally, everyone from the Communist party chiefs on down assumed its success was due to the superiority of what they were calling at the time “Capitalism with Chinese characteristics.” With a better grasp of English they might have used the term “fascist.” Either way, in retrospect, the smart money is that it was simple isolation saved China’s bacon rather than anything we’d call economic management.

In Beijing’s defense, it is hard to draw a practical conclusion when the real world is incompatible with a deeply held ideology. As Upton Sinclair wrote: ““It is difficult to get a man to understand something, when his salary depends on his not understanding it.” Chairman Mao was such a true believer in the face of his country’s economic devastation that even the Soviets told “little brother” to pump the breaks on the revolution. Mao did understand, however, that his rivals in the CCP were starting to sneer so the Chairman triggered the Cultural Revolution in 1966 – and it must be the only youth rebellion against authority in history to be sparked by a 73-year-old cult of personality autocrat. When Mao died in 1976, the CCP established a two-term limit on ultimate power so it wouldn’t happen again. 

His successor Deng Xiaopeng veered away from Maoism as hard any sensible person could under the circumstances. The short version is that the country lurched from a poverty-stricken backwater to merely poor by cornering the market on shower flip-flops and cheap sunglasses. After joining the World Trade Organization (WTO) in 2001, the country got dubbed the Asian Tiger for stealing all sorts of innovative technology and was the world’s second largest economy by 2011. It’s hard to recall, but at the time, most of the hated gweilos – a Cantonese slang meaning “White Goblin” or “Foreign Devil” or something equally charming – were falling over themselves to welcome China’s ascent to the WTO. Sort of like offering a rich kid a Sigma Chi bid because you need the dues and you just hope he’ll be less weird once he joins. And for a while, turning a blind eye to all the intellectual property theft, seemed to have worked.

Xi Jinping was a provincial, mostly boring, bureaucrat - or at least he appeared to be. When he took power in 2013, the party insiders in Beijing weren’t entire clear where he’d come from; other than that his father had been important enough to be eaten by the Mao’s Cultural Revolution. Xi was part that class of “little princelings”, which is what the Chinese call the children of party elites from which the party draws future leaders. This is the system the CCP uses to ensure that China will never backslide into a system of hereditary privilege. In Xi’s second year in office, foreign investors were given greater access to Chinese stocks via Hong Kong. All seemed swell and financial journalists started scrambling for Crouching Tiger Hidden Dragon metaphors.

Then in 2018, in Xi’s second – and what should have been final - term, someone noticed that just under $30bn was flowing out of the country and into the US real estate market. Xi decided to exert some control and steer the whole thing back into a big Maoist hug. From an economic or human freedom point of view, communism is bad idea on a good day. As it was, the world was about to embark on a series of very bad days, made worse by ham-handed attempts by government’s the world over to fix them.

In 2019, Xi decided that having the kitchen door open to the free-wheeling West was a bad idea, which led to the security crack-down in Hong Kong. In 202O came the covid lockdowns which would trickle on, in one awful form or another, for three years. That was also the year of the crack-down on Big Tech that rolled into an even heavier crack-down on Hong Kong that has done its best to kill the city as a financial center.

While baffling to a capitalist, the method behind Xi’s thought process was that baseline Marxist assumption that all of history points to the ultimate triumph of communism. That a sympathetic consolidation of historic forces is moving in China’s favor and against the West. A couple of uppity tech billionaires were not going to stand in the way of the revolution. The Soviets had the same theory and – given the ideology’s circular logic – the USSR’s collapse only proves Xi’s point: Moscow lost faith, and the system fell apart.

Practically speaking, a solid belief in the grand forces of history over simple cause and effect makes for skittish and arbitrary policy. Yet nowhere in Xi’s personal history is there really anything to suggest that the man is mercurial. All reliable sources paint a picture of a man so stable that you’d never notice him until it was too late – let’s call it “stealth boredom.”

Even if few in China really know how he wound up at the center of a cult of personality, it doesn’t change the fact that there he is. And any man who would publish a book called Xi Jinping Thought and make it a mandatory school course every year is not likely the sort of man to sit still for a lecture in basic finance. The end result being that Xi simply doesn’t understand the global free market in which he finds himself a major player.

Had Xi spent his time reading Adam Smith rather than Chairman Mao, he’d have known that attempting to stuff the capitalist genie back into the bottle is ill-advised. Marxists think that manufactured goods are neatly divisible from the knowledge that it takes to make them, as well as the ideas on which that knowledge is based. That may not sound like much when your economy dominates the market on carnival prizes, but once micro-chips and advanced programming enter the picture the learning curve gets pretty steep. Xi seems to know that there is a problem – but his training and devotion in an impractical economic theory creates a disconnect that can only be maintained by the true believer.

Down in the trenches, where people actually have to earn a living they are a little more practical. And dubious. Forces of history rarely move fast enough to do your retirement account any favors. Chinese investors and entrepreneurs are losing confidence in the system. Analysts reckon that the country’s capital outflows are in the neighborhood of $500bn, although Beijing’s balance of payments data are hazy. Last year some $13.6bn went in to the US property market – and that was after both countries passed laws restricting investment.

Foreign investors have lost confidence as well. For better than a decade returns were fine, but they never really lived up to the hype or, for that matter, the official numbers. Last year China and Hong Kong stocks were the worst performers in the world. Something has misfired, but the Communist Party gets pretty touchy when foreigners have the bad form to notice it. So Beijing classed most garden-variety Western due diligence as “espionage.”

Given the bath that foreign companies have taken in the wake of Russia’s invasion of Ukraine, these antics are not going to help FDI. Now that the exodus has started, it’s hard to see why investors would come back anytime soon. Still, there are places to go… Which brings us back to India – since 2021 they’re stock market is up by 35%.

Happy Diwali to you, too.

How To Wreck a Middle Class

In college I wrote a paper arguing the reason why Russian communism collapsed and the Chinese version survived was essentially that the Beijing was smart enough not to believe its own bullshit. This no longer appears to be the case.

The Marxism that Beijing conveniently ignored for the last 30 years is back, once again requiring ideology to trump reality. One of the more cherished, and ignored, elements of communist ideology is the notion that everything belongs to “the people.” So every blue moon, the party is obliged to pretend that it knows the people are there.

Lord knows that America’s congress takes long vacations, but the big gathering of the People’s National Congress (PNC) in Beijing only happens once a year – and only for a week. The gathering of the PNC is held in conjunction with its advisory committee, just to make sure that “the people” don’t get any funny ideas. They call this the “two sessions.” Only one of them matters. Unlike America’s barking, obstructionist congress, the PNC is a rubber stamp affair more akin to the national conventions of US political parties. You already know the fix is in, but it is useful of see what the people in charge are thinking and how, precisely, they are likely to ruin your year.

There was the usual bell ringing, and China has had some notable successes: Last year it overtook Japan as the world’s largest automaker. This was largely due to the EV sector, where BYD briefly over took Tesla as the largest EV maker. And riding that high, prime minister Li Quang announced the ambitious growth target of that China’s growth of 5%. That’s a tall order for a strategy of doubling-down on an export-led economy in a global market that currently hates you.

Domestically, things are worse. Three thousand years of ham-handed central management has made the Chinese a fairly thrifty lot, and communism didn’t make them any flashier. Opening up the economy has – sort of. That single downward blip in property prices in 2008 enticed Chinese investors into the same trap as their American counterparts: Holding on to that peculiar notion that property prices will always go up. Now some 25% of Chinese savings are in the rapidly crumbling property sector. Beijing’s attempts to gently deflate property bubble has only hurt that section of the economy on which its growth depends: The people who thought that they were solidly middle class. Stocks make up a smaller chunk, but Chinese markets have lost $7trn in the last three years. None of which is going to help domestic consumption, but the medium-term problem is more social than economic.

Anyone with hint of wealth in China is neuvo-riche; in my grandfather’s day the entire place was an economic misfire and anything that we’d call old money was eaten up by the people’s revolution. While it is romantic (and very Marxist) to believe that revolution comes from the lower classes rising up against their greedy oppressors, in reality, that doesn’t happen very often. Revolutions almost exclusively come from what Eric Hoffer called the new poor: The staunchly middle class who have recently taken a humiliating slide down the socio-economic ladder. The French revolution, the rise of the Bolsheviks and the Nazi’s were all were fishing from the new poor for their powerbase to wreck the existing order. The Iranian Revolution succeeded only with the help the liberal middle class who thought they were establishing a democracy. The Arab Spring was a revolt of the college educated who thought that they’d have a job waiting for them at graduation.

The term “princelings” to describe those funneled into China’s ruling class is not meant as a term of reverence. It is an apt description of a people who inherit great wealth and power without ever understanding its source. And the history books are figuratively littered with their corpses. Like a lot of princelings, Xi is a narcissist, unlike most of them, he’s managed to roll it into a Cult-of-Personality issuing little books and a school course called Xi Jinping Thought that place ideology above economic and geopolitical reality. And like anyone whose world-view is no longer ham-strung by reality, he has a couple of blind-spots. The most glaring is that if China plans to achieve the innovation based and value-added economy it sees for itself, it needs an educated and driven middle class. And that cohort needs to be large, doing well, and have some hope for the future.

Granted, China already has a generation that came out of poverty and managed to do well out of the system that opened up in the 1980’s. In the West, this would be seen as a huge leap forward. Xi sees capitalism, and the middle class that it produced, as a threat to his cult as well as the power of party. He needs to push the uppity neuvo-riche back down the ladder.

If history serves as an example, they won’t go quietly.

An Expensive Waste of Time

Pushing the only people with money to splash around into neuvo-poor really is no way to stimulate a consumer society. The production part of the equation is easy enough to manage if you are willing to print the yuan to make it happen: Just tell the good people over at BYD to churn out more electric cars, subsidize the extra shifts and there we are – heaps of shiny, unsold BYD Seagulls.  The rub is that you can’t really force the wary, and poor, consumer to buy one. Or, if supply is going to meet demand, four of them.

You could just cut production, but then you’d have to lay people off and face the prospect of a bunch of unemployed men, without enough women to go around, on just enough sustenance welfare to start grumbling about “social contracts.” It must really miff the communists to go to all the time and trouble to create a society beyond rude capitalism to know that none of it works unless there is a capitalist out there, somewhere, will to buy your manufactures. That 5% growth they were advertising at the big communist “two sessions” get together is going to be achieved only by having the rest of the world absorb all that excess production.   

Unlike the last Cold War, the global order is an intricately interdependent one. So naturally when an economy the size of China starts thinking about dumping cheap, subsidized goods on the finely calibrated global market, the US feels compelled to stick its nose in the business. In early April, US Treasury Secretary Janet Yellen wrapped up four days of high-level talks in Beijing, and left carrying on about striking a “conciliatory tone” and putting the relationship between the world’s two largest economies on a more “stable footing.” Which is high-end diplomacy for “an expensive waste of time.” Well, Janet, most diplomacy is.

While Yellen was scolding her counterparts to quit flirting with Moscow, they were doing just that. Sergei Lavrov, Russia's Foreign Minister, was in Beijing at the time and was reportedly very grateful for the assist in rebuilding Russia’s hollowed military capacity. Nor did it help that while chewing the conciliatory bacon on the mainland, out in the South China Sea the US kicked off joint naval and air exercises with Japan, Australia and the Philippines – where the Chinese navy likes to pummel local ships with water cannon.

Unlike the rest of the dumpster fire that is global geopolitics, however, the rub with China isn’t really military – not yet at any rate. Beijing doesn’t want a war with America and given the way that Biden’s White House staff walks back anything he says about Taiwan, it isn’t likely to get one. The tension is over what the world sees as another round of “China Shock.” That’s where Beijing directs heaps of state money into ramping up manufacturing far beyond domestic demand and dumps a heavily subsidized surplus on the world at bargain basement prices. The last time they did this, in the early 2000s, it is estimated that it cost the US some 2mm manufacturing jobs.

The wheeze worked so well that you can hardly blame them for wanting to try it again, now that their economy is currently in the can. So we responded with 100% tariffs on those BYD EV’s and a host of other goods. True there are plenty of other markets in the world, but practically speaking, the “global south” doesn’t have the money. And that leaves Europe as the last gweiloson the planet rich enough to absorb Chinese overproduction.

The EU is less enthused about the plan. The European Commission has launched an anti-subsidy probe on a Chinese wind-turbine maker. With additional probes on subsidies in EV and solar panels coming as a flood of the Chinese solar panels has already shuttered several European green tech companies. Twenty years ago, the US could be philosophical about the loss of manufacturing jobs because we were flying-high on a pile of money and thinking that the dot.com bubble would take us to a place where we didn’t need those old economy jobs. After this century’s financial meltdown, migration crisis, covid lockdowns and the Russia getting expansive, a “China Shock” might take Europe to the point of no return. On the other hand, if Beijing can’t find another sucker to finance its economy and fiscal policy, it might find itself in a similar position.

Which is not to say that there isn’t a military component to all of this. China’s PLA Navy seems to get a kick out of bombarding hapless Philippine coast guard ships in the South China Sea. President Xi has repeatedly ordered the PLA to be ready to take Taiwan by force by 2027. In May, a week after Taiwan’s president was sworn in, China surrounded the island in a military simulation of an invasion to punish the country for electing a man who did NOT want to change the status quo. Military yes, but there is also an element of political theater here – why would anyone announce their intentions and then practice an invasion in front of everyone? I’m a Southerner, I went to the University of Alabama, and can attest that no SEC football coach worthy of the name – not even Tommy Tuberville – would let a rival coach in to watch squad practice. 

Given how theatrical politics have gotten, the guess here is that Beijing is trying to benefit from Vladimir Putin’s “he’s just crazy enough to do it” vibe while staying aloof from the dirty trenches of geopolitics for a long as it can. While the US ties up options trying to preserve the status quo, Beijing wants to preserve its range of maneuver for what it thinks is coming next. Which is a hell of a lot more military than economic.

Again, we come to another one of those baseline assumptions baked into communism – with Chinese characteristics or the original vodka and furry hat variety – is that the West must eventually be confronted if China is to prevail. Co-existence is not an endgame, but a pause to gather strength for the confrontation. The USSR abandoning the policy as fruitless by the late 1960’s is largely the reason for the Sino/Soviet split. So Xi Jinping, so far as the man can theoretically smile, thinks that he’s having the last laugh.

It’s not enough to be communist, you have to be anti-Western. Xi is convinced that the liberal world order is foreign, essentially Western concept (it is) that is stacked against China (it’s not), and so must be upturned. Yet his country is economically tied to that hated system. Or, to be more precise, its past meteoric success is from gaming the liberal world order to its advantage through asymmetrical trade barriers. The Goose that Laid the Golden Egg, it seems, is not in the Ancient Chinese Wisdom canon.

Xi isn’t appear to be after a coherent trade policy, fair or not. The man seems bent on revenge. His history is littered with what the Chinese call “The Century of Humiliation” wherein Western powers forced China to open its markets to European exploitation. He still seethes about the era’s “unequal treaties” and appears to want to force China’s own unequal treaties on the qweilos. He has over-estimated his ability to do so.

China’s economic outlook is going to get worse before it gets better, and that is assuming that its demographics don’t cause the whole model to collapse before then. There is one option that never really works as well as deranged leaders think it will, but it’s popular nonetheless. It’s worth remembering that at the close of the Two Sessions Xi said that the youth of China should learn to “eat bitterness” for the struggle ahead – and if that isn’t something you say to prepare for war, I don’t know what is.

Containing China: We May Not Need To...

In 1946 an obscure US diplomat stationed in Moscow named George Kennan sent a 5,000+ word cable that became known as the “long telegram.” It argued that the Soviet Union would collapse under the weight of its own history and internal contradictions. All the United States needed to do in order to triumph over the communist system was keep it broadly contained. Washington sorts tend to like short, broad strokes, nor can they leave well-enough alone. Somehow, policy makers shagged the concept into the “domino theory” that convinced everyone that the hinge of the free world was an unwinnable colonial war over a backward, feudal scrap of Indochina. Later, Kennan was at pains to point out that he hadn’t said that at all.

In the face of a superpower rivalry that would rather see the other dead, Keenan’s original concept of “containment” is back in vogue. Beijing openly accuses the United States of attempting to contain China, which would be more offensive were both President Biden and the secretary of state openly admitting it.

So ... how the hell do we contain China?

When Keenan wrote the long telegram, the United States accounted for some 50% of the world’s GDP and dwarfed the Soviet Union’s economy. Even then, Washington knew it needed to allies bought with the Marshall Plan and a global security blanket. Now US share of global GDP (weighted for PPP), is 15.8%, compared with China’s 18.8%. What this means practically is that the United States can’t unilaterally contain China – not economically at least – to pull it off we need to have Europe’s 14.8% share and, ideally, India’s 7.8% on our side. It’s not at all clear that we do.

That 100% tariff on Chinese EVs that America was never going to buy in the first place may be getting all the headlines, but measures like prohibiting the sale of high-end chips and technology will do more harm for what China wants to achieve. Other measures, like those on green technology, will annoy Beijing, but are chapping European rear-ends as well. It’s hard to get a buy-in from allies when our tariffs are screwing them nearly as bad as our rivals. On the off-chance that Washington realizes that US economic and foreign policy interests are the same, we might be able to pull it off.

As Keenan argued in 1946, other than keep free markets open between allies, we don’t actually have to do much of anything for the system to ultimately collapse. Still, containing China, if it can be done, is going to hurt worse than boxing in the Soviets which had a completely isolated economic system. The interdependence brought on by a globalization means that the more tariff pressure placed on Beijing, the greater will be the counter-pressure from the world’s manufacturing hub and biggest exporter. The resulting trade wars and friend-shoring will be wildly expensive for pretty much everything. And that’s after it wrecks the supply chain.

The good news is that, like the USSR, China envisions being the anchor of its own bloc of nations to displace the West’s markets and influence – but BRICS or the “Global South” lacks any sort of cohesion or consensus. They all seem to hate each other. All those Road and Belt Initiative loans to developing countries was supposed to buy influence in markets. But as those loans turn bad, unless the IMF bails them out, Beijing will be faced with either repossessing entire countries, or eating the loans.

China’s political alliances aren’t much better. Russia and Iran are increasingly isolated and exposed to regime collapse. A fact being exploited by non-state actors that Beijing simply doesn’t understand (neither does Washington, for that matter). North Korea, for its part, made itself obvious earlier this week not with another nuclear test, but by floating bags of trash and poo to the south tied to balloons. That’s how you build a pledge class, not a world power.

Domestically, China’s labor costs are rising faster than any industrialized nation – triggered by the economic boom of the last 20 years, and will be made worse by the demographic collapse coming in the next 20. It is only maintaining its manufacturing edge with massive, unsustainable government subsidies. Xi’s fundamental misunderstanding of the free market demographics likely means that his policies will keep lurching from one half-baked scheme to another. The man may very well have a lifetime grip on power, but in his 70’s, and that lifetime won’t last forever. He interrupted the regular transfer of power to make himself a cult of personality, so without an heir apparent, the question of succession will probably get very messy.

Mind, China is a big country and a massive economy and anything that size is fundamentally stable. Up to a pint. As Beijing finds itself increasingly isolated, trying to corner the market in a world with plenty of other back-waters to take up cheap manufacturing, the boom can’t last forever.

So how do the US contain China? The short answer is that it doesn’t, not alone at any rate. Whether the US wants to admit it or not, it hasn’t got the heft to bend the entire world to its will. The good news is that we may not need to. Which raises the more intriguing question, how to make money with the big pagoda collapses?