Is it just me or are China’s reactions increasingly unhinged?

Part of my investment thesis on China is that the underlying structural issues have been laid bare by the trade war. Regardless of any face-saving deal, the problems will not go away. China’s reactions to three events in the past week appear increasingly unhinged and are likely to accelerate the process.

Background

China entered the World Trade Organisation in 2001 as a poor, authoritarian country with promises to become less autocratic and the chance to become less poor. 

Over the next 18 years, China managed to get itself into an incredible position – critical supplier to the world without liberalising its political system. The USSR never managed this trick, and it actually became a democracy (for a short time at least).

Problems laid bare: Western Countries

At the heart of the problem is that Western countries don’t usually have integrated trade relationships with authoritarian regimes. Mind you, there are plenty of vested interests suggesting there is no problem with dealing with authoritarian regimes. Those arguments tend not to win in the long term.

Trump didn’t start the trade war as a defence of freedom and to limit the risk for companies though. He just wanted to get the jobs back for the poorer voters in the US, the casualties of China taking over low-end manufacturing.

Problems laid bare: China

China’s problem is it wants to escape the middle-income trap. To do so, China needs to move up the value chain and take tech leadership. The US doesn’t want to give up tech leadership. 

Scientific breakthroughs and tech leadership tend to come through a liberal society that encourages freedom of thought and challenging the status quo. So, China is already facing structural issues on that front.

To achieve tech leadership, it is alleged China has been stealing tech secrets and forcing technology transfer on companies who operate in China. A range of articles appeared over the last year, highlighting spying, surveillance and corporate theft to support that view. It would appear these have been part of a co-ordinated leaking process by Western governments and spy agencies. I expect these were designed to bring these issues to the forefront of corporate decision making. 

With the spying laid bare, there is a serious problem for Chinese technology. Let us say you are the Chief Information Officer at a major multi-national with corporate secrets and customer details to protect. Five years ago, the question was: do you buy hardware from China for 15% cheaper than the same equipment from Japan or the US? Now, the question is: do you buy potentially compromised hardware from China for 15% cheaper? There is a big difference.

A cosmetic trade deal won’t solve the problem

There may well be a deal coming. Any deal is likely to be cosmetic only.

China wants tech leadership, liberal democracies are not willing to give it. Why rely on sensitive parts of high tech equipment to a country with a history of spying on / locking up its own citizens?

Trump has already set the ball in motion. Multi-nationals have started a decade-long process to make China less of the supply chain. These processes are unlikely to be reversed.

Increasingly Unhinged

So, you would think China’s best position would be to try to get the world back to thinking China is not a threat. Lie low, make comforting noises about becoming less authoritarian.

Instead, in the last week alone China has chosen to:

  1. Pick a meaningless fight with the NBA over a tweet from a minor administrative official displaying vague support for Hong Kong. Then, compounded the problem by escalating the fight because the initial retractions weren’t obsequious enough.
  2. Convince a US gaming company (Activision Blizzard) to strip the prize money from a Hong Kong e-sports player who voiced support for the protests, and then ban that player for a year.
  3. Ban and remove South Park from the Chinese internet for an episode suggesting Chinese censors are too harsh. Actually, this one was pretty predictable and likely what South Park had intended.

But now there has been a backlash to the backlash, suggesting China has very much overplayed its hand. 

A range of politicians from both sides of the US political spectrum lined up to decry the NBA’s first weak attempt to appease China. Now it has blown into such a significant issue there is little chance that the NBA will back down. A backlash against Activision is also starting to grow. 

Regardless, these are yet more signs of the fundamental problems in the US-China relationship.

Australia: Caught in the middle

Australia has also been managing a delicate political process, how to profit from China by selling commodities but maintain a close relationship with the rest of the democratic world. We will likely be forced to choose one or the other. My expectation is Australia will choose democracy over profits – but there are be plenty of vested interests urging the opposite.

How should you be investing in this environment

In our Nucleus superannuation and investment portfolios, clients who have strong ethical concerns can exclude stocks that don’t meet their views. This includes Human Rights or democracy issues, helping with ethical superannuation investing:

Nucleus Investors can choose to exclude countries with poor human rights records from their investments

From a stock selection perspective, it is about trade-offs. The key questions we have been asking of our stocks for the past year:

  1. How much does the company have to lose if its access to the China market is restricted?
  2. How much does the company have to gain if Chinese competitors are restricted?

An example of the type of investment theme we are targetting is companies involved in factory automation. As companies increasingly move supply chains out of China, we believe that the process of automating factories with robots will be accelerated.

There has been a range of warnings from Trump about the problems of doing business with China.

However, it seems as if the loudest warnings about doing business with China are now coming from China itself.   

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Damien Klassen is Head of Investments at the Macrobusiness Fund, which is powered by Nucleus Wealth.

The information on this blog contains general information and does not take into account your personal objectives, financial situation or needs. Past performance is not an indication of future performance. Damien Klassen is an authorised representative of Nucleus Wealth Management, a Corporate Authorised Representative of Nucleus Advice Pty Ltd – AFSL 515796.

Comments

  1. Ronin8317MEMBER

    The proposition that China wants to escape the middle income trap is wrong. It actually wants to remain a developing country forever with low labour cost so it doesn’t need to reform, the dilemma is it simply isn’t possible.

    As to Activision/Blizzard, Call of Duty makes more money than Heartstone, so Blizzard got thrown under the bus. International companies don’t have any morality anymore. Same with the NBA.

    To put the HK protest into perspective : if protesters start fire bombing the metro in New York, you think the NYPD will be as lenient as the HK police? This has grown from peaceful protest to a full scale insurrection. This will not end well.

    • All that’s needed is for something unfortunate to happen to, say, Joshua Wong and it will be Chicago 1968, after Luther-King, all over again!

    • Yes, try marching Pine Gap out of Australia and see what happens to you. We always start by demonising those we intend to attack.

      Watching Ecuador, if they can overthrow the Neolibs then I expect the recent CIA coup in Brazil to unwind as well

    • Of course China would love to be rich, every country would. It has no desire to remain a middle income country. Which is of course a different to issue to whether it will remain one (I believe it will remain a developing middle income country for a long time).

      • Let me correct that for you. The elites who control china would like to become wealthier. To do this they need and endless supply of labour at a lower cost than the rest of the world.
        Replace china with australia and the statement is just as true and explains the endless “skilled immigration” being ued to supress australian wages.

        • Income distribution is a different issue. Of course they want their GDP per capita to be as large as possible. And of course the richer parts often want the distribution of this to be skewed in their favour. But they don’t want their GDP per capita to stagnate.

          • Even the rulers in australia don’t care that gdp per capita is falling. gdp per capita is irrelevant. income for those with power is all that matters,

    • Companies as well as those who invest in those companies, the quickest road to big dividends and profits is to run the company into the ground by stripping it down as much as possible while ripping off the loyal fans until their trust runs try. I hate the world of public companies and shares, it destroys almost any video game company that enters it.

    • Interesting claim but it makes sense to an extent: authoritarian regimes only survive by keeping their populations compliant and servile but to become a rich nation you need to teach your populations ‘how’ to think, which itself could threaten the regime down the road. Currently, the CCP are content to teach their citizens ‘what’ to think but it won’t get the country to the promised land, so they’re in a fix. As Damo says, they need to steal commercial secrets to bridge the gap.

      Many South American countries are similar in a fashion – they are run by elites whose main interest is keeping the population uneducated and dependent.

  2. USSR never became democratic but rather disintegrated while some ex-members became democracies (baltic states) while some are hardcore dictatorships (Turkmenistan or Uzbekistan until few years back), and most somewhere in between

    At the heart of the problem is that Western countries don’t usually have integrated trade relationships with authoritarian regimes.

    really?
    how about middle eastern oil rich countries like Saudi Arabia, UAE, … they have been well integrated for decades
    and in the past … since WWII there were so many dictatorships they enjoyed nice relations with the West (some of the worst dictatorships were even installed by the West – Pinochet)
    numerous dictatorships in South and Central America well integrated with US economy
    middle eastern dictatorships, in addition to those that are still dictatorships Iran under Pahlavi, Iraq under Sadam, …
    Asian dictatorships in South Korea, Taiwan, Singapore, Philippines, … all part of western economic system
    some of the dictatorships in Europe were also fine like Spain under Franco, Portugal under Salazar, Greece and Turkey under few military juntas end even some semi-communist ones like Yugoslavia under Tito.

    • True, the Saudis act like petulant children and everyone pats them on the back in a comforting manner.

    • Damien KlassenMEMBER

      Western countries will absolutely buy commodities from dictatorships and repressed regimes – you forgot to include Russia on your list which is the biggest supplier of gas to Europe.
      But that is a far cry from an integrated supply chain on the scale of what we see in China.
      I’ll give you Singapore on your list of dictatorships with integrated supply chains but that is about it. South Korea currently ranks higher on the Economist’s “democracy index” than the USA!

      • Taiwan, South Korea,Philippines, Singapore … were examples from recent past not necessarily present
        Integration of Taiwan and South Korea few decades ago (when they were dictatorships) was not shy of current Chinese integration.
        Russia is not only source of gas but many other commodities.

  3. What if this is all propaganda by our elites to control US ?

    Stir up anti Chinese sentiment to steel our resolve and create support for a trade/hot war

    It’s a potential explanation for otherwise inexplicable behaviour

    Just theorising
    Maybe I need to put down the tin foil

    • Using War to energise economic activity is a tried and proven method of elites.
      With economic activity world wide in the doldrums …
      On the other hand , tackling the Climate Crisis would , one might think, offer a way forward.
      The manpower, rescouces , needed to convert the world energy and transportation systems, the food production, could stimulate the economies, if the vested interests are made to see the future is the key to our success, not the past.

  4. Damien. Good post. But, Trump started the trade war for his own benefit/reelection. Throwing scraps to his loyal supporters. But only his loyal farmers (actually large agri business) have been compensated at great cost.

  5. Scientific breakthroughs and tech leadership tend to come through a liberal society that encourages freedom of thought and challenging the status quo.

    This can’t be right. I’m told here all the time that diversity is weakness and success comes when everyone looks, thinks and acts the same way.

    • I guess it depends on how success is measured. Peacefulness comes when poeple think and act the same way. Conflict is a result of people having significantly different thoughts and actions.
      At a societal level success comes when most people just plod along doing what they are told is expected of them, and only a very few are required to “think differently” to progress society.

  6. It’s quite amusing watching these virtue signalling SJW MNCs like the NBA and activision blizzard squirming with their current predicaments. It was all fine and dandy to support idiots like Colin Kapernick and other kneelers dissing the US when there was no obvious or immediate financial consequences but exercising free speech in the face of communist China threatening to pull coverage and sponsorship must be stamped out! The solution should now be obvious to ALL MNCs – begin to decouple from China. No board or CEO in their right mind will put new investments into China and existing investments, to the extent they can be moved away, should be. We need to decouple from this heinous totalitarian state – the quicker the better.

  7. The area in which I live in Sydney has become a mainland Chinese canton. One thing I have learned is that the mainland Chinese think differently to the west. Not better or worse, just differently. So you must be careful in assuming they see the world as we see it, or will respond to things the way we respond.. (Hong Kong / Singaporean / Malaysian Chinese are much more likely to see things the same way as us).

    • Ronin8317MEMBER

      The average Chinese that grew up in China before the 90s will experience a childhood where having meat to eat is a luxury. It is difficult for people outside China to understand how fast the country grew in just a few decades, and why they see the CCP as benevolent rather than tyrannical.

  8. It’s hilarious how many unforced errors they’re making.

    Can’t be too much longer before they cross a line that pushes the self-righteous Europeans reluctantly toward Orange Man.

    It’s been fascinating watching the world slowly shift in that direction in real time. Though ultimately terrifying.