The China Perplex

Nary a day goes by when we do not read a story about China’s economic implosion. Apparently, the Middle Kingdom is suffering something like an economic contraction, and more than a few Americans are cheering from the sidelines.

For the record, the Wall Street Journal did report on China’s economic troubles this morning. But, it also ran an article explaining that the only major economy to contract in 2023 is-- you guessed it-- Germany.

Anyway, we now seem to believe that we need not compete with China, that we need not improve our own economy, because China is in a doom loop, a death spiral that will return it to third world status. By the by, the concept of doom loop is more often used to describe some of America’s formerly great blue cities.

So, are we seeing China clearly or are we indulging in wishful thinking? Do we believe that our liberal society is so much better than their authoritarian system that we need but watch as they implode.

After all, consider that our democracy has chosen leaders like senile Joe Biden and idiot Kamala Harris. What could possibly go wrong?

After all, the business press is just waking up to the idea that, because of tariffs and sanctions, as we are importing less from China, that nation has outsourced its manufacturing to countries like Vietnam and Mexico. It ships materials to those countries and resells them to the United States.

So, as I say, less cheering and more sober reflection is needed.

Consider an article, by Hong Kong banker, Louis-Vincent Gave in the Financial Times a couple of days ago. Link unavailable.

Gave indulges in a little of what market participants call contrary thinking. And he opens his column by listing the ills that are befalling China, ills that resemble those that once inflicted our liberal capitalist paradise:

Prop­erty prices are fall­ing. Large developers have fallen into dire straits. A big fin­an­cial con­glom­er­ate has missed interest pay­ments on products sold to investors. For many, such recent events in the coun­try feel like the remake of a 2008 film few enjoyed.

The gloom­i­est fore­tell the unfold­ing implo­sion of the Chinese eco­nomy with years of over­build­ing, white ele­phant projects and unpro­duct­ive infra­struc­ture spend­ing finally com­ing home to roost.

It’s not a pretty picture. But, is it the whole picture, or is it simply a distortion peddled by the media in order to make us feel better about our inability to compete? After all, Chinese children are leading the world in academic achievement, while the vast majority in our blue city public school systems cannot do math or languages at grade level.

Banker Gave suggests that bank performance is the canary in the coal mine. When the economy is tanking, banks suffer:

In most fin­an­cial crises, the share price per­form­ance of banks starts sig­nalling trouble months before a sys­temic crisis unfolds.

For example, the S&P Com­pos­ite 1500 Bank index fell 66 per cent between Janu­ary 2007 and July 15 2008 before Leh­man Broth­ers col­lapsed in Septem­ber that year.

Sim­il­arly, European banks, as meas­ured by the MSCI EMU bank index, shed 35.4 per cent between Janu­ary 1 2010 and August 1 2011 — before sov­er­eign bond yields on the euro­zone’s peri­phery star­ted to blow out, unleash­ing the euro crisis.

So, how have Chinese bank stocks been doing lately? Glad you asked:

With this in mind, over the past 12 months, Chinese bank shares (as meas­ured by the FTSE China A-Share bank index) have gained 2.4 per cent (without account­ing for dividends). This means over that period, Chinese banks have out­per­formed US banks by 12.6 per cent in dol­lar terms.

So what does one call an emer­ging mar­ket sys­temic fin­an­cial crisis in which local banks are up on the year and out­per­form­ing US banks by double digits?

There are really only two pos­sible answers — unpre­ced­en­ted or non-exist­ent.

As though that is not enough bad news, local Chinese government bonds have been outperforming American treasury bonds. 

And, the price of the most China-sensitive commodity, iron ore, has been rising over the past few months. It’s not what you would expect in a contracting economy. 

The past year has also seen the share prices of China-sens­it­ive west­ern com­pan­ies such as LVMH, Hermès, Fer­rari and oth­ers do par­tic­u­larly well.

In fact, most lux­ury goods pro­du­cers are trad­ing at, or close to, all-time highs. This would seem coun­ter­in­tu­it­ive if China really were facing a sys­temic melt­down.

And, that’s not all:

Domestic tour­ism is broadly pick­ing up. Car sales in China are still up this year des­pite a small decline in June and July. Alibaba just repor­ted a return to strong sales growth in its second-quarter res­ults. Yet more signs of an eco­nomy that is not implod­ing.

That is not to deny that China’s eco­nomy faces genu­ine chal­lenges or that Chinese eco­nomic growth is slow­ing, cyc­lic­ally and struc­tur­ally.

But in short, there seems to be a strong dis­con­nect between the price beha­viour of most China-related assets, whether at home or abroad, and fears of an unfold­ing sys­temic crisis.

And yet, relations between America and China are at a low point. Out commerce secretary, Gina Raimondo, recently traveled to China to repair ties. 

Moreover, American companies are having a harder time doing business in China. Of course, Chinese companies in America are also under attack. So, quid pro quo; tit for tat.

If you did not expect this possible outcome of our tariff and sanctions regime, you were not paying attention. Somehow we imagine that we can do our best to cripple certain Chinese industries, without suffering any blowback.

Now, we must also recognize that one prominent presidential candidate, a former president, wants to end free trade with China. Good-bye Adam Smith. Call it for what it is, a trade war.

Clearly, we have strengths and weaknesses in said trade war, but tossing aside a fundamental principle of economic growth and wealth production does not seem like the smartest idea. 

Besides, as I have occasionally noted, when you are doing your best to damage the international reputation of another country, do not expect very much cooperation. Do not expect cooperation over Russia. Do not expect cooperation over the Fentanyl crisis. Do not expect that that other nation will continue supplying your medications in a timely fashion. As we note shortages of medications, we should ask where those drugs are manufactured. You will recall that the Trump administration promoted Rochester, N. Y. as a new hub for manufacturing pharmaceuticals. Unfortunately, it was just wishful thinking. It never worked out.

Aside from the fact that life is complicated and that you cannot do foreign policy on the principle that we are all good and they are all bad, that whatever we do is good and whatever they do is bad, this rather distorted thinking sounds a great deal like what is called in another context, identity politics.

So, if you believe in the notion of contrary opinion, the stock market forecasting tool that invests according to negative sentiment, on the assuming that most of the people are wrong most of the time, it may be time to take off the blinders and take another look at China.