China syndrome

In the late 1960s, after 35 years abroad working for the Yankee dollar, my Uncle Walter returned to England not exactly rich, but comfortable enough. Chiefly to stave off the boredom of life in Virginia Water, he took a clerical job at the Bank of England. It was there he ran into China’s cultural revolution.

This was a time when Mao Zedong’s red guards, brandishing the Little Red Book, were running amok even in London’s West End as they pursued the destruction of the ‘four olds’. Meanwhile, in that summer of 1967 and away from the mayhem outside the front door of the Chinese embassy in Portland Place, every Friday morning, as punctilious as a butler, a man from the embassy staff would slip out of the back door and take the Underground from Regent’s Park to Bank. There, he would go to the bank’s debt-management office in the basement to meet Uncle Walter. From his brief case he would hand over bundles of cheques, all drawn on the People’s Bank of China, in order to service the loans the glorious republic had borrowed from the Old Lady. No matter that the cultural revolution would tear down the bourgeois edifice of capitalism, the debts of the people’s republic would be honoured. The red guards may be ready to slaughter the running dogs of Wall Street (probably of Threadneedle Street, too), but less excitable functionaries would pay interest in full, on time and in a hard currency.

The purpose of this anecdote – pretty well true, by the way – is to show that China’s state apparatus almost always knows where the nation’s best interests lie. The rhetoric might point one way, but the reality points in the direction of self-interest. If that applied during the chaos engendered by Mao, think how much more it should apply while comparatively sensible people are in charge.

If this is correct – and assuming it continues to hold good – the West’s worst fears about its future relations with China are exaggerated. If correct, it also remains imperative that equity investors with a long-term investment horizon keep a chunk of capital tied to the performance of China’s economy. This holds good despite the strong showing of China’s equity markets compared with the rest of the world and especially with the UK (see Table 1).

True, mean regression may result in the UK’s underperformance – chiefly dating from 2016 – correcting itself in the coming years. That would justify no more than lightening exposure to China, perhaps not even that. Whether investors choose an active or a passive route into China’s equities is largely subjective. The table points to the superior performance of the active path. That may not persist, although the heavy exposure of China exchange traded funds (ETFs) towards state-controlled monoliths implies that ETFs will generally be second best.

But – and, of course, there is a ‘but’ – it might not work out that way. It may be right to take the pessimistic view. China won’t be destroyed in the way that Mao’s divide-and-rule politics threatened to, yet its economy – although not as brittle as Donald Trump reckoned – may not effortlessly pass the US’s as the world’s biggest. Nor will it implode in the way Russia’s did in the last years of communist rule. Yet it still might end up as nothing better than the biggest of the developing markets and, in consequence, be as unreliable a place to invest in as India or Brazil.

The parallel with Russia, in its Soviet-Union guise, is relevant because it points to a major weakness facing China – it is powered by ideology. As we discussed a few weeks ago (Investors' Chronicle, 19 March 2021), ideology always spells problems because it rests on the lie of infallibility and, sooner or later, that lie will be exposed. This led to the demise of Russia’s brand of communism and it almost did for China’s at least three times when Mao’s chronic insecurity descended to especially dark levels. For malevolent indifference to human suffering, almost nothing exceeds the madness of Mao’s Great Leap Forward of 1958-62.

China’s present supreme leader, Xi Jinping, seems to be made of more pragmatic stuff. Yet danger clearly lies in the way he has been able to accumulate power on a scale unequalled since Mao. Predictably, this has generated something approaching a cult of personality and, where once there was Mao’s Little Red Book, now there is Xi Jinping Thought or, to give the work its full and racy title, Xi Jinping Thought on Socialism with Chinese Characteristics for a New Era.

The title hints of a book that could have benefited from tighter editing, yet – more seriously – Xi deals with the issue of ideology head on. “Why did the Soviet Union disintegrate?” he asks. “An important reason was that the struggle in the field of ideology was extremely intense, completely negating the history of the Soviet Union”.

In that observation lies an important truth – to too great an extent, the leaders of Soviet Russia overdosed on ideology and forgot about or even abused their country’s past; much as Mao did with catastrophic consequences for China. They forgot that, for a nation’s leaders, history – or what can be concocted as history – is almost always a source of strength since the people they seek to control adhere to values shaped by the past, by custom and practice. Consequently, people are almost always more conservative than their leaders. The obverse also applies – when a nation’s leaders show contempt for what people revere, sooner or later people will show contempt for their leaders.

This simple observation goes a long way to explain why modern China might be described as an exercise in ideology but with a historical face; alternatively as an exercise not in socialism but in nationalism. To date, that has mostly meant economic nationalism via orthodox mercantilism that would not have looked out of place in 18th century Europe. Whether – and to what extent – that will turn to military nationalism may yet be dictated by another major weakness that China must confront in the coming decades – its lousy demographics.

To explain, turn to Table 2. Despite China’s amazing economic progress over the past 40 years, it remains far from being rich. The conventional assumption is that its output is on an inexorable path to exceed that of the US, but it is still far from that goal. In current US dollars, its output is still only two-thirds that of the US; although usefully more if account is taken of China’s low cost of living and the measure is made in terms of local purchasing power.

Table 2 also shows that, to a large extent, China remains an almighty great capital-spending project funded by cheap domestic savings. Capital spending still runs at twice the rate of the UK and US, as does the rate of saving. There are shortcomings inherent in this. First, too many capital projects may be duds, only good for producing a banking crisis (although, in fairness, this long-standing concern has yet to materialise). Second, the high rate of saving points to other weaknesses. One of these is that China’s state, despite its reputation for authoritarian efficiency, is limited in its scope and especially light on welfare provision. So the absence of safety nets taken for granted in the West means that China’s middle classes must save more than they would do otherwise, in the process dulling the growth in consumer spending that would make China’s economy more evenly balanced.

There is another reason for all this saving, which is where demographics comes in. It is not just that no country has ever become rich without having the right demographics in the form of a huge resource of cheap, young workers. This applied to China as much as it applied to Japan 30 years earlier, to the US 70 years before that and so on back to the start of the industrial revolution. China’s demographic dividend is set to run out. As the table shows, its old-age dependency ratio is low compared with developed countries, but that will change in the next 30 years. Meanwhile, the proportion of its population that are children is much the same as the developed world’s.

With China, however, there is a sinister difference. It has unnatural numbers of boys, which drives much saving. The cost of raising a child is ferocious. It’s not just the cost of education. If the child is a boy, then provision must be made for a dowry. Without a dowry – plus, of course, the approved educational qualifications and the right job – the little emperor won’t get a Chinese wife; an exaggeration, but too close to the truth. For this, one can blame China’s cultural norms and Mao Zedong’s one-child policy. Together, these have resulted in the genocide of baby girls. With the exception of India, no country comes close to China’s unnatural ratio of boys to girls at birth.

This may have unintended consequences beyond a miserable childhood. Roughly speaking, there are already 30m to 40m more young men than young women in the country and one question is what to do with these angry young men who will never find a Chinese wife. “Send them off to the army,” is a flippant response, but it might actually help bend China’s nationalism in a more militaristic direction.

And yet this may be too pessimistic. We might look on the bright side and say that, yes, China’s sex ratio at birth of 113 boys to 100 girls is unnatural. But at least it is improving. Ten years ago the ratio was 124 to 100. Generally, that’s how it is. Countries become better places to live as they become richer. There is no obvious reason why China should be an exception to that rule. Perhaps the West projects too many of its own fears onto China. Perhaps we should pay more attention to Uncle Walter’s assessment of the man from the Chinese embassy who delivered the cheques every week even while Mao’s cultural revolution raged: “He seemed quite a normal chap, really.”