By Eric Peters, CIO of One River Asset Management
“In the early 2000s, mainland China was perhaps 5-10% of the Asian capital markets, and China appeared likely to grow in a symbiotic way with the US,” said the CIO from Asia. “That path is now gone, and the possible scenarios are not nearly as hopeful as back then,” continued one of the region’s leading investors. “But knowing that the future is not as bright is different from knowing how it will unfold,” he said. “So, for that, we break the future into a number of possibilities, then watch for signs that tilt the odds toward one or the other.”
"China is highly indebted and leveraged, so Xi is attempting to open up because he needs to attract foreign capital,” added the same Asian CIO. “He’s playing a confidence game, and it is vital for his survival that he win it,” he said. “In less than 20yrs China has come to represent 70% of Asia’s capital markets.” With such dominance, any investment decision in the region has become a call on whether you want to be long China. “Xi is looking to attract $5trln of foreign capital to plug holes, levering it 10x-15x through the state banking system.”
"The bullish China case is that Xi gets his $5trln, levers it, and uses excess capital to secure dominance in the industries of the future," explained the CIO, referencing artificial intelligence, biotech, microchips. “Along that road, Xi will leverage all the industries that China already dominates to secure advantage.” Solar, batteries, LCD panel production. "And while the US may draw away, the Germans and French are ultimately commercial and if China can produce the best products, and consume European luxury exports, Beijing may just win."
"The bear US case is a derivative of China’s bull case,” he explained. "The US net international investment position is -$13trln.” To maintain its economic dominance, it needs to continue to attract enormous capital inflows. "What allowed the US to sustain this imbalance is global confidence in its legal/political systems alongside an incentive structure that rewards entrepreneurship, but if the nation swings between Trumpism and Sanderism in the decade ahead, that confidence is undermined. And investors will seek to diversify away from America."
"The bear case for China is that Xi is clearly an authoritarian,” said the Asian CIO. "He imposes so much control over Chinese companies – which he already has – that the rest of the world refuses to use Chinese IOT (internet-of-things) technology.” Fear that Beijing will ultimately have access to all our data is seen as unacceptable. "This then kills so many of China’s talented entrepreneurs." Leaving them unable to expand beyond their domestic market. "They can only be as big as the economy is successful – and so China fails to attract the $5trln."
"China is now fully engaged in a financial war with the United States," said the CIO from Asia. "And this view rises all the way to the top of the power structure in Beijing," continued one of the region’s leading investors.
“Whatever can attract foreign capital to China is seen by Beijing as being in the national interest,” he said. “So if it is in the national interest for a leading Chinese technology company to fabricate flattering financial results, the government might be fine with that."
In times of war, rules shift to meet national needs. In a world where capital is desperate for evidence of growth, fabricating the latter to attract the former is a rational strategy. Failing to attract capital is unacceptable for a nation with an inflating property bubble which simultaneously supports tax revenue, employment and domestic consumption. US pressure to re-engineer global supply chains could not come at a worse time for the Beijing Acrobats, their plates spinning, slowing.
And this amplifies the pressure to maintain an appearance of prosperity so that the foreign capital continues to flow in.
“We have always had to be somewhat skeptical of economic statistics and corporate figures coming out of China, but in a time of financial war we may see distortions on a scale never before seen,” he said. "For the time being, western money is flowing in even as capital controls are tightening for locals. Foreign pensions, endowments, they’re seeking greater diversification for their portfolios.”
And if this doesn’t work, the Chinese may choose to become more assertive regionally, and coopt the sources of capital surplus that fund US deficits – HK, Taiwan, Korea, Japan. Under Biden both the Saudis and Russians will surely be more allied to Beijing.
"But the foundation for investing so much money in China is unstable,” said the CIO. “One must invest very carefully in China and be skeptical of all the numbers that are presented."