Dan Wang, a China-based reporter for many years, writes an insightful book about his impressions of the Chinese economy and political system in Breakneck: China’s Quest to Engineer the Future. The premise is that China's economy and political system are run by engineers, who are the key filter for understanding their leaders’ actions and behavior in addressing problems. In contrast, the US is driven by lawyers who are not builders and doers but activists who want to stop and control the economy and politics through the legal and regulatory system. On the surface, this dichotomy seems simplistic, yet Wang makes a strong case that this is an effective characterization. He does spend most of his time using the engineering framework to explain China, the center of the book, and his contrast with the US is not as well developed, yet I found this may be a good way of thinking about actions within China.
This is a short, very personal book, so do not expect deep analysis. Yet the presentation is compelling, and for those who want another perspective on the Chinese economy, it is a good read.
The Chinese stock indices have been strong performers, matching those of other major countries around the world. This increase is despite an overall economy that is not doing very well. The real estate markets remain morbid, but sentiment has changed regarding trade wars and geopolitical risks.
The strong China tech sector may be about relative valuation. Chinese tech is cheap relative to similar US firms. It is also associated with a government focus on growing the tech sector, both to avoid dependence on the US and to increase the opportunity to dominate this industry globally. Since the launch of Deepseek AI, there has clearly been more attention to this sector. Clearly, Chinese tech is being pulled along by the strong US moves.
China (PBoC) cut its benchmark interest rate and reduced reserve requirements for bank to support the targeted growth rate of 5 percent. The 7-day Repo rate was moved from 1.7 to 1.5% with reserve requirements dropped .5% and a signal that there would be further cuts later this year. This adds about 1trillion in RMB liquidity. It was also announced that 500 billion RMB will be used to help brokers, insurance companies and funds to buy stocks and the PBoC will use 300 billion RMB to help firms conduct stock buybacks. The PBoC lowered mortgage downpayment for second homes from 25 to 15% and it would improve terms for its 300 billion RMB programs to help local government-owned enterprises to buy unsold inventory from property developers.
This is a robust stimulus program which has provided a strong market bounce. Equities are up nearly 10% for the week. This is the best since 2008, but there are structural problems that still have not been addressed. Consumer confidence and a change in the direction of policy to consumer spending from exports and investment has not occurred. Allowing for private companies to better compete is not really on the table.
The China economy is a global driver for growth for the simple reason it is a big economy and has a large trade footprint, but the current state of the Chinese economy is negative and not getting better, so China is likely it will be a drag on global growth for the rest of the year and well into 2025.
Consumer confidence is low and not improving. The animal spirits of optimism do not exist.
The real estate market continues to grind lower which impacts wealth and consumer spending. You can have strong consumer confidence it the largest investment of consumer is falling in price.
The PMI numbers are weak and clearly show a recessionary. environment for the real economy. Businesses are not making money.
The stock market pushes lower and is not providing a positive signal for the economy.
Finally monetary policy is pushing rates slower, yet government policies are tilted to stagnation as economic data are suppressed and there is little innovation in policy.
This weakness will show in commodity prices and in global trade. It is a growth headwind.
China cut its five-year prime loan by 25 bps while keeping 1-year loan rates the same. The 5-year rate is the key mortgage rate. The PBOC cut reserve requirements by 50 bps on February 5th.
All of this is being done to improve the real estate market which has been languishing with developers facing an ongoing credit crisis. This cut may not solve the problem because China is dealing with a balance sheet problem not a cost of borrowing problem. The cut will not help banks which are already facing a problem of lower net interest margins. Home prices are falling. Investors are not interested in buying given the structural problems that developers may not finish projects. The cost of capital does not matter when you don't think the principal will hold value.
Rates have been falling for years. Prices are declining not just seeing slower inflation. China is an economy that is sick and the cure is not going to be just lowering rates. There is now a real estate confidence problem which is not a credit pricing problem.
The forecasts for China growth have fallen significantly in the last three months and are now below the target level set by the government. The PBOC has responded with rate cuts, but there is now the growing view that this is not a liquidity problem but a structural problem. As said by Michael Pettis, "As Keynes explained over 90 years ago, liquidity is a constraint on investment, not a cause."
You can make funds available at attractive rates but if there are no good projects or no optimism about the future, there will be no new borrowing. The borrowing should not be by the government, but by firms that believe there is a reason to expand. This expansion has to be domestic and not based on more trade. The constraint is not liquidity but animal spirits, the optimism that there is a reason to invest,
Stephen Roach is a long-time Wall Street economist who was the chairman of Morgan Stanley Asia for several years and a current fellow at Yale University. He has been commented on China-US relations for decades through his varied experiences. His new book, Accidental Conflict: America, China, and the Clash of False Narratives, is an attempt to address the key problem of how to get the two major powers of the world to candidly talk with each other in a construction manner.
Roach covers ground that many have already explored. There is a shared history. There is a strong codependency with China having high excess savings and the US engaged in excessive spending. The savings imbalance links both countries in a close relationship whether anyone likes it. The savings imbalance story is hard for policymakers to understand. Setting up tariffs and trade constraints is not going to solve the problem. Micro solutions to macro problems are providing the wrong first aid for chronic problems. This applies to both the US and China. China needs to reduce savings and become more consumer focused. The US needs to increase savings and investment.
The US has a false narrative about China motivations and actions which are often economically rational, and the China has false narratives that are generated to maintain the current power structure within China. The extension of current narratives lead to conflict as each party responds to real and perceived falsehoods. Standing down through cooperation is an optimal solution yet is not the solution that most will choose. Game theory, while not explicitly discussed, provides us with a framework of how solutions can be found, yet the obvious solution is not always the first choice when politics are driven by rhetoric targeted to the average citizen of each country.
Roach provides detailed information on China and US relations and each reaction over the last few decades, but the overall story could have been condensed into a tighter presentation. I agree with his false narrative presentation, but I am afraid that this framework is simplistic and does not address the complexities of the competitive conflict that has arisen over the last two decades. We have expected that by having China enter the WTO, it would be ripe for change into a more democratic/ capitalist country. This was a false premise that is the crux of the current problem.
Can both countries move beyond the false narratives described by Roach? I am not optimistic. False narratives are hard to reverse because the falsehoods are often wrapped in some basic truths. China and the US are competitors, yet for the good of the world this competition must be tempered though finding a common ground of trust.
Investment and economic views concerning China are key to global market success in 2023 especially since there is the view that the US will likely be in a recession starting in the second half of the year.
There is a clear geopolitical risk based on the tensions with the US surrounding trade and Taiwan. This uncertainty slows long-term investment. Who will invest in fixed plant and equipment when the 5 to 10 year horizon is cloudy? This uncertainty only increases based on the unclear market and regulatory environment inside China.
The cloudiness is embedded in stock prices, yet there is a more positive investment message for the short-term. One, COVID restrictions have been lifted. The November rally is clear. Two, there has been an increase in credit available for investment through looser monetary policy. The PBOC is not following the western approach of monetary tightening. Three, the economic data are stronger as presented by the recent PMI especially for non-manufacturing spending. An increase in Chinese consumer spending can be a strong factor for global growth if there is an increase in imports.
The economics of China are a mystery to most investors. It has grown so fast that many do not fully digest the magnitude and influence of China on the rest of the world economy. Even for those who do understand the impact of China, there is limited understanding of how it got to its position and its economic development through time. As important, understanding the relationship between China and globalization is critical.
Yeling Tan, non-resident senior fellow, PIIE, discussed "China's Development Models in an Era of Global Disruption" and concluded that China has had a conflicted relationship with globalization and has engaged in a hybrid development model.
The 1980's were a period of reform and opening especially with trade liberalization along the coasts. The 1990's saw an explosion of growth based on coastal development followed by a retrenchment during the Asian financial crisis that focused on state-led spending. The period of WTO entry was another era of strong growth but with a resistance to true opening of trade. The global financial crisis again caused a shift away from external growth thinking. The Belt and Road Initiative was another outreach for growth but on terms favorable for internal development. The Trade War with the US again caused a change in globalization focus with more emphasis on diversity and decoupling. Currently, the COVID pandemic creates a focus on internal systems and structures and less engagement.
Globalization and engagement have had a mixed history with China's development. It is important to understand that China swings between external and internal focus which impacts growth, development, and integration with the rest of the world.
An underpriced economic tail risk facing investors is from the China slowdown associated with zero tolerance COVID lockdowns. The CAIXIN China composite PMI fell to below 40 this week, the worst reading since the beginning of the pandemic.
A current systemic risk is the continued asymmetric globalization between the US and China. Remember the "Chimerica" meme that was the rage in the post-WTO period. That is over. Asymmetric globalization may not be shock threat, but it is a risk that drive markets lower.
China would like to disconnect with the West but still accept capital, western institutions, and technology on its own terms. China would like sell goods to the West and only import capital goods that will further improve their terms of trade or technology. China would like to control commodity imports to ensure that they are not dependent on other countries. Trade will have to be strategic. The US would like to be more strategic with China trade, but the particulars are less clear.
A key tension between countries is the move to globalization versus a form of modern mercantilism. In the case of the US and China, there is often globalization rhetoric and mercantilist behavior. The producer country wants to have open markets but also control its internal positioning against multinational control. The importing country would like more control over imports but realize the cost of import limits in the short run are high.
The asymmetric globalization becomes more obvious when culture and political systems clash, but it exists in many countries - a desire to be export globalists but import mercantilists. Asymmetric globalization is also played-out at the class level. Rich countries or rich educated individuals are clearly more pro globalization than poor countries and less educated classes where the benefits may not seem as clear.
This asymmetry affects all global and EM equity and fixed income benchmarking. It also affects all companies that have China revenue and capital exposure or China companies that have listed in the US. How should you allocate capital when this country threat exists? If you have not addressed this question, you are behind the curve in your asset allocation.
Clearly, there are unknowns concerning the disposition of Evergrande where the rule of bankruptcy law is unclear. This event uncertainty is present everyday as news reports and analysis describe the lack of clarity on what will happen with a potential failure that will run into the hundreds of billions.
Evergrande is not an isolated incident of an unknown solution in a world of China policy certainty. The Economic Policy Uncertainty Indices for China show an explosion over the last two years as measured by mainland newspapers and the South China Morning Post SCMP. Uncertainty has fallen from highs over the last two years but is still at elevated levels and may be poised to grow higher. For the more general investor, the uncertainty index is a better measure of the overall business climate than a single company event.