Tuesday 14, December 2021

On China

China is a global superpower. It is also, notionally a communist state. In its current form, it is the result of support given by the Soviet Union to Mao Tse Tung. Weirdly, the Soviet Union is gone, but its client state, China, now has overtaken the USA in terms of GDP and is probably a much bigger threat to world peace than the USSR ever was. (OK, the US has a bigger GDP at market rates, but at purchasing power parity China is already bigger. China has kept its currency undervalued for a long time to boost its exports.)

The USA has indulged China since Nixon visited Mao in 1972 (1971?). Both China and the US saw that an alliance of convenience was their best chance of defusing the threat posed by the USSR. Even now Russia is a third or fourth rank power, China continues to get favourable treatment from the USA, and from Europe. I am not entirely sure why. It is either the fact that voters like cheap manufactured goods, or that governments like to avoid raising taxes sufficiently to pay for their spending progammes. In fact, right wing governments like to cut taxes, which is only possible because China is the buyer of last resort of US Treasuries. Support for US Treasuries supports European and Japanese government bonds, via central bank swap lines and repo markets.

The world has a “safe asset” shortage, which is satisfied, largely, by US Treasuries. But they are only safe because China keeps buying them. And China only keeps buying them, because they receive dollars for all their exports, and at least Treasuries pay a yield of sorts. (as much as 1.4%).

The problem is that it seems likely that China will soon be running a current account deficit, or at least a surplus so low that it cannot absorb more than a tiny part of the US budget deficit. China is not the only big exporter to the US, and maybe Vietnam or Korea will be happy to pick up the slack, but it doesn’t seem likely. The other problem is that as China pivots to a more service-based economy, it has no need to hold its currency down. It might want to take control of monetary policy, so it will have to let its currency float. For most currencies, allowing the currency to float means allowing it to sink, often rapidly. For China, it seems likely that it really will bob upwards. This is the argument for buying Chinese assets, and assets in countries that are tightly coupled with China economically, such as Korea, Taiwan, Vietnam.

I haven’t seen much evidence of this happening yet, because of the Evergrande effect. Many Chinese stocks have started unravelling, as investors realize that the place is a cesspit of corruption. Maybe there are Chinese companies with good governance. Maybe there are Chinese companies with bad governance which will still make a lot of money for ordinary investors. I’m waiting and watching, but I am not going to go long Evergrande any time soon.