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By Barry Goodman
co-CEO and Executive Director of Trading
Many apply linear thinking to China when the nonlinear variety is more appropriate given the country's many idiosyncrasies. We prefer a more nuanced approach that allows us to consider a wide range of scenarios and capitalize on opportunities along the spectrum connecting binary extremes. This is the sort of integrative thinking that we believe is required when contemplating a place like China, where creative solutions often reside between opposing ideas.
Taking such an approach requires domain expertise that is difficult to acquire. Indeed, much of the knowledge we foreigners possess about China is superficial. This can be demonstrated by popular anecdotes we commonly associate with the country. The saying "may you live in interesting times'' is often misattributed to an ancient Chinese curse when it actually rephrases a comment made by a former British statesman. Some in our position might note how the Chinese word for crisis combines the characters for "danger" and "opportunity." But the proper translation of the character for "opportunity" in this context is "incipient moment or inflection point," which we believe more accurately describes the current state of play.
We are not naive to the many challenges facing China today.
The country's domestic debt situation appears especially problematic, particularly as it relates to property developers and local governments. As of the middle of last year, China's total debt exceeded 280% of GDP—among the highest in the world—and recent estimates pegged the country's local debt pile at $23 trillion. It is difficult to ascertain what percentage of that debt is non-performing. Chinese commercial banks have previously claimed it to be just 1.6%—which might be a function of shadow banking's role in real estate financing—but credit investors are pricing listed debt at less than half of book value. For reference, the total value of subprime mortgage loans leading up to the Global Financial Crisis (GFC) was estimated at $1.3 trillion.
Funding problems involving two of China's largest property developers—Country Garden and Evergrande—may serve as a harbinger of things to come. Some have drawn parallels to the beginning stages of the GFC, calling this China's own Lehman moment. The recent market rout in the Chinese equity markets was a shot across the bow, despite the strong recovery that was seen as engineered in large part by Chinese leadership.
Other echoes from recent history ring even more ominous. In addition to accumulating mountains of debt and experiencing a bursting of its property bubble, Japan also suffers from the inverted demographic pyramid that worries China watchers today. Just as many predicted Japan would usurp the U.S. in the 1980s—only to see the country backslide into lost decades of decline—China may be following a similar trajectory that sees hype eventually give way to disappointment.
The list goes on. Youth unemployment is at all-time highs. Cash-strapped consumers and local governments are creating deflationary pressures. The post-COVID rebound many predicted has failed to materialize, evidenced by contractionary measures in manufacturing and overall business sentiment.
The rising tensions with the West have exacerbated the situation, leading to sanctions aimed at curbing some of China's high-tech manufacturing capabilities. Such geopolitical uncertainty adds to ongoing frustrations with the speed of reform, general security concerns, and state support of local competitors, causing many Western businesses to scale back their local operations or abandon the country altogether. U.S. Commerce Secretary Gina Raimondo officially warned her Chinese counterparts that American companies increasingly view China as uninvestable. And European Chamber president Jens Eskeland recently noted that business confidence in China is "pretty much the lowest on record."
So, we agree there is plenty to worry about regarding China. Relations between the West and China may continue to sour from here, making the country increasingly untenable as a business destination. China could be on its way to repeating history as it follows Japan's path. And we cannot discount the possibility of a simmering Cold War exploding into a hot one. This could all end poorly.
Maybe yes, maybe no.
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