There are a number of reasons for the current litany of gloom about China, but the actual state of the economy is way down the list. This is primarily because narrative and emotion dominate facts in the short- and medium-term. The narrative on China has undoubtedly taken on a powerful Geo-Political edge in the last three years, as the US has realised that China’s intentions to move further up the value-added-curve threatened its own economic dominance. Tariffs and incentives to re-shoring were straight from the playbook used against Japan in the 1980s, but the situation with China is very different, not least because of the emergence of the BRICS+ grouping and the powerful impulse to multi-polarity produced by the “freezing” of Russian Foreign Exchange reserves last February.
Instead of merely excluding China from western markets, the US narrative makers are now trying to convince the whole of BRICS+ – which now includes almost half the world’s population – that the US Economic development model is a better one than China’s. Hence, all bad data to be emphasised and all good data to be played down.
In addition, western investors – understandably wary of the risk of investment sanctions from their own governments – have noted political declarations that “China is un-investable” and acted accordingly, with significant outflows in recent months. Naturally, such (dis)investors are keen to hear a good “fundamental” story as to why they were “correct” to have sold. Accordingly, the market narrative-makers have joined the political narrative-makers to deliver a “glass half empty” portrayal. This is the problem with most market narratives; there are positive and negatives and data to support both sides of most arguments, which is particularly true of China. It is so large and so diverse that data can be found to support either a bull or a bear case.
There is, however, a more fundamental misunderstanding about China in markets, which stems from a persistent belief that China is just like all other emerging markets. Except, of course it isn’t, and it never has been. In the first instance, China deliberately chose not to follow all the standard rules required under the US-led Washington Consensus model for economic development. Observing the failures of other emerging markets that consistently failed to emerge, the Chinese authorities chose not to open up their capital account, nor to float their exchange rate. They did allow workers to move off the farms to work in factories, but they didn’t let western corporations own the factories, nor did they switch their farms to a plantation-based export model requiring them to import basic foodstuff from the west.
They welcomed foreign direct investment (FDI), but a large domestic savings base meant that they didn’t need to borrow heavily in USD to fund their banking system, nor did they emulate the US model of heavy mortgage debt and consumer borrowing. Meanwhile, in allowing their agricultural workers to move to factories in the cities they nevertheless had a strict licensing system known as Hukou to prevent the emergence of the favellas, townships and slums that beset so many other emerging markets. In short, the Chinese put in practice what legendary investor Charlie Munger describes as “inversion;” instead of asking “how can we make China better?” they asked, “how can we really mess it up?” And then made sure they didn’t do any of that.
As a result, China has been consistently criticised by western economists for not following the formula recommended by the World Bank and the IMF. The more China has prospered, in spite of their advice, the more the western economists have doubled down and the more the politicians have become concerned that the rest of the world may start adopting the “more successful” China model of development; especially at a time when the world is polarising and the BRICS+ are starting to bypass the US financial system. This is the second element of the western model that China has rejected; the financialisation model, where all public goods and services are sold off to the private sector and, usually, loaded up with debt, whereupon privatised monopolies extract enormous “rents” for overseas investors. Such is the myopia of financial markets that they conflate what is a good thing for them, with what is a good thing for the Chinese economy as a whole.
Which brings us to the property sector, the current focus of the “China is bad” narrative, even though the collapse of the property bubble is now well into its third year. However, as with the collapse of the shadow banking system a few years back, what the markets are missing is that this is a controlled demolition.
The authorities have been well aware of the flaws of the property sector for years, in particular the fact that customer deposits were not being used to fund working capital for their own project, but to buy land for the next one, or even the one after that. Sooner or later, they needed to call time, but they also needed housing to be built and the local government to receive the revenues from the land sales to build the public goods and infrastructure vital for economic development; as opposed to letting it be funded by overseas investors. Time was called three years ago and the fact that western investors were eight of the top 10 largest holders of property stocks, like Country Garden, almost certainly explains why the west regards the 95% drop in its share price as a bigger deal than the Chinese government does. Their focus is on making sure the actual property buyers get their homes.
The bottom line is that China is aware of the problems they face and the fact that the policies that they follow rarely accord with western advice is largely down to their practice of inversion. The concern for western politicians is that the more they succeed using their own policy mix, the more the rest of the world may practice their own form of inversion. Hence the narrative management. Investors, however, might choose to look at it from a Chinese perspective and see it as a process of Creative Destruction; focussing on what is created, not just what is being destroyed.
