NOT INVESTING IN CHINA: “VERY RISKY”

Ray Dalio, the founder of Bridgewater Associates, the world’s biggest hedge fund, in an interview on 6th Aug, calls NOT investing in China and its future “very risky”1.
Let’s explore the following: China’s growth and stability, as well as the risks.

 

Growth

In 2000, US consumption levels were 13 times larger than China’s. It’s now just above 2 times (see chart below), and China is poised to get richer.

Despite the trade war causing China’s economy to slow further, it is still growing. China has also deliberately slowed so that certain sectors would not overheat and cause asset bubbles.

As explained by Dalio, the conflict between the US and China is a ”natural development”, as China has grown and expanded and what’s happening isn’t dissimilar to conflicts in history1 when there is a rising new power.

We think that the US President Donald Trump’s tactic is to intensify trade tensions and THEN reach a deal to declare victory before the 2020 election in order to secure it. The Chinese leadership, on the other hand, reached a consensus in late May and were prepared to fight a prolonged trade war with the US at the cost of more pains to the domestic economy2.

The Chinese government is aware and has also taken steps to boost demand domestically (see chart below for growth compared to other nations).

Trade (reflected as net exports below) is also forming a smaller and smaller part of its GDP:

Stability

On 11th March 2018, China’s President Xi Jinping was allowed to remain “president for life” when term limits were removed. This was considered radical even when he had “already established himself as the most powerful Chinese leader since Deng Xiaoping3.”

“Xi has demonstrated that he is a competent, serious, balanced leader who has improved the economy, enhanced China’s global reach, strengthened its already significant military capability, and reduced corruption – a significant set of achievements in the public’s eyes. With his potential to rule China for another decade or longer, China will experience a steady hand on the tiller of public policy3.”

Even though the “Made in China 2025” (MIC2025) rhetoric was dropped as a tactical move, it IS being implemented, and represents the Chinese Communist Party’s official marching orders for Chinese companies to become global leaders in ten core industries by 2025. “Beijing has adjusted its industrial policy, reacted to setbacks, set up pilot projects, and invested heavily in research and development in strategically important industries in the recent past” in order to fulfill it – just like the GDP targets they set before4.
Led by a steadfast visionary with results to boot, China is definitely one country to follow. Yet, what about the current risks that we’ve been hearing about?

 

Will the Trade War with US cause China to go into recession and tech companies to leave? 

No. Both the US and China are affected by the trade war. However, with domestic consumption rising and trade falling in terms of contribution to China’s GDP, the impact of the trade war may not be as significant as China has also measures in place to support growth.

Contrary to many media reports, the trade war was not the sole reason that made tech companies leave the country – “rising labour costs, nascent domestic competition, difficulties in profit repatriation, and concerns surrounding the protection of intellectual property are all factors placing increased pressure on foreign tech firms.” Some tech companies are leaving for Southeast Asian countries, but these countries still do not match up to China’s high-tech manufacturing ecosystem5.

 

Will the trade war affect MIC2025?
Not really. The trade war will affect MIC2025 if US decides to cut off all essential technological supplies to China. We think the above scenario is unlikely as the impact to the US companies would be disastrous, as China is one of the largest consumers of such technological supplies. We think the trade war would, on the contrary, accelerate MIC2025 as this trade war would make China more determined to achieve self-sufficiency soonest.

Despite the restrictions, “China has already secured itself a strong position in areas such as AI, new energy (electric and hydrogen) and intelligent connected vehicles. The electric vehicle (EV) battery market serves as a powerful example of how quickly such dynamics may unfold and global value chains are absorbed. In 2017, seven of the top ten EV battery companies were Chinese, accounting for 53 percent of the global market share4.”

 

Will there be a sharp devaluation in the Chinese Yuan and in turn affect the investments?

No. The Chinese Yuan broke 7 per US dollar earlier as Trump announced additional tariffs. The Yuan had last transacted above this rate in Mar 2008.

Essentially, China did not even meet US’s definition of what it means to be a currency manipulator6; and what China did was to stop the Yuan from falling too much, and not to devalue it. It is not likely that China would devalue its currency to counter the trade war. It had cost them a cool US$1 trillion in foreign exchange reserves to prop the currency up7 so as to stem the currency outflows in 2015-16 when the currency weakened from 6.2 to 6.96 per US dollar.


Will China’s debt create a crisis?

Unlikely. According to a report published by the Institute of International Finance8, the nation’s total debt is 3 times their GDP. Recognising the risk to the economy, the government has stepped in with President Xi Jinping and his lieutenants vowing then in 2016 to rein in borrowing so as to lower the risks. China had begun deleveraging that year, and that led to a crackdown on unregulated lending – so-called shadow banking9. Also, much of China’s and the Chinese companies’ debt are in their local currency, which is much more manageable in the hands of the domestic authorities.

 

Will the protests in Hong Kong affect China?

Not much. Hong Kong is a “tiny place” in a “very big vibrant economy”, said Dalio10. And the
fundamentals of the companies listed actually haven’t changed, even though the Hang Seng index dropped about 14 percent since its highest peak this year.

Thus, we have deemed China fit – and the long-term attractiveness intact.

Dalio also mentioned, “It’s better to be early than to be late in terms of investing (in China).

Think about it. Would you have not wanted to have invested with the Dutch in the Dutch empire? Would you have not wanted to have invested in the industrial revolution and the British Empire? Would you have not wanted to have invested in the United States? I think [China is] comparable. Would you have not wanted to have invested in those places?1

Where would you have invested then? And where would you invest now?

 

References:

1.South China Morning Post 7th Aug 2019: Bridgewater’s Ray Dalio says investors should still bet on China despite trade war

2.BNP Paribas 6th Aug 2019: Chi Flash – China Named China Named A Currency Manipulator. What If It Stops Intervening?

3.Bloomberg 27th Feb 2018: All Hail (and Fear) Emperor Xi

4.Mercator Institute for China Studies 2nd July 2019: Evolving Made in China 2025

5.China Briefing 6th Aug 2019: Are Foreign High-Tech Companies Really Leaving China?

6.BNP Paribas 5th Aug 2019: Chi Flash – Sino-us Strategic Trade Recalculations Pushes CNY-USD Beyond 7. What Next?

7.Quartz 6th May 2019: For all the hubbub about the US-China trade war, trade is a fraction of China’s economy

8.Bloomberg 16th July 2019: China’s Debt Ratio Is Growing as Its Economy Loses Steam

9.South China Morning Post 19th Dec 2018: China offers low-cost loans to banks to help fund small businesses, shore up economy

10.CNBC 16th Aug 2019: Hong Kong protests will be ‘settled or crushed’ ahead of China national celebrations, analyst says

 

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