The yuan slipped to its weakest level in six months, pressured by concern surrounding China’s growth outlook and a surge in U.S. Treasury yields.

China’s offshore currency weakened by as much as 0.7% to 6.4198 per dollar in New York trading, its weakest since October 2021. The decline comes as traders eye the risk that the world’s second-largest economy is becoming snarled in lockdowns, quarantine and testing rules. The yuan was also pressured by a rise in U.S. yields and the greenback on odds of even more aggressive Federal Reserve tightening. 

On Monday, China’s central bank unveiled nearly two dozen measures and promises intended to boost lending and support industries that have been beaten down by recent Covid lockdowns, including a pledge to guide banks to expand loan extensions.

“This is the strongest signal yet from Chinese authorities that they are concerned over growth conditions,” said Simon Harvey, head of currency analysis at Monex Europe. “Coupled with regulatory tightening in the tech sector, the increased level of concern over domestic growth suggests a poor year for Chinese equity returns. Today’s currency reaction is reflective of this.”

Although first-quarter GDP data showed a pick-up in growth, a deceleration in production and retail data in March as economists further worried about China’s growth outlook amid damage from lockdowns. 

In the U.S., meantime, investors are ramping up bets for the size of the Fed’s next interest rate hike. While markets are generally pricing in a 50-basis-point hike, St. Louis Fed President James Bullard said Monday that hikes of as much as 75 basis points shouldn’t be ruled out. Treasury yields surged across the curve on Tuesday, with the benchmark 30-year bond rising above 3% for the first time in three years.

That likely deepened losses for the yuan, which on Tuesday breached the key support level of its 200-day moving average. Japan’s yen also plunged, set to extend its longest losing streak in more than half a century.

Slowing consumer spending is beginning to weigh on the Chinese economy and not least as house prices post negative performance. The Chinese government has been very slow to act because they are aware of how overt stimulative action inflates asset bubbles, and prices are already high. Nevertheless, they probably fear social unrest from high unemployment and negative growth more.  

As shown, the working age population in the U.S. is expected to be relatively flat whereas both Europe and China will likely experience a significant decline. The key point is that economic growth is equal to the sum of growth in the working age population and productivity growth. Therefore, unless China can stimulate significant productivity growth, it can expect a significant slowdown in economic growth. While not top of mind for most Americans, this likely slowdown has important implications for the U.S. First, slower economic growth may cause socio-political issues for the Chinese government which may further complicate already tense international relations. Second, a shrinking workforce in China will likely result in higher wages which may import inflation to the U.S. given our dependency on China for the manufacturing and assembly of so many types of goods. Third, recent supply constraints in the U.S. will likely continue on a sporadic basis. Finally, a maturing population in China will consume internally more of what it produces. This example is so fascinating because the unintended consequences of a forty year old policy decision are currently impacting the entire globe.

A link to the full report is posted in the Subscriber's Area. 

This chart included with this report highlighting the reversal of working age population growth in China, Europe and the USA is particularly relevant. It suggests a migration of manufacturing and labour-intensive activity to lower median age countries is inevitable over the coming decade.

In 2020 I began a series of reviews of longer-term themes which will be updated going forward on the first Friday or Monday of every month. These reviews can be found via the search bar using the term “Secular Themes Review”.

“Play along to get along” has been the default strategy for global peace over the past thirty years. The default proposition was that if we concentrate on commerce, and all grow wealthy together, there was no real need to focus on our political differences. Under that system globalization flourished.

A just in time global supply chain allowed components to be made in a host of different countries, assembled in China and exported to the world. The demise of subsidy regimes allowed commodities, particularly agriculture products, to be produced in the lowest cost regions and exported to the globe. The internet has allowed the dissemination of know-how and services like never before.

In attacking Ukraine, Russia expressed a willingness to risk being cut off from much of the global economy. Regardless, of any other motive, Russia’s invasion of Ukraine is a gamechanger for the global order. With evidence of war crimes emerging, the chances of Russia being welcomed back into the global trading community are growing progressively more distant. We are back in an “Us versus them” global environment.

Chinese stocks listed in the U.S. fell Thursday after Securities and Exchange Commission Chair Gary Gensler dialed down prospects of an imminent deal to allow Chinese firms to keep trading on American exchanges.

The Nasdaq Golden Dragon China Index dropped as much as 4.9%, with iQIYI Inc. and Baidu Inc. sinking more than 6% after being added late Wednesday to SEC’s growing delisting watch list. Alibaba Group Holding Ltd. fell 4.6%, while its e-commerce rivals JD.com Inc. and Pinduoduo Inc. slid more than 7%.

U.S.-listed China stocks have steadied in recent trading after authorities signaled support to overseas listings and financial markets, yet investors remain on edge amid a long-standing dispute over whether American regulators can get full access to U.S.-traded Chinese company audits. In response to the SEC chair’s comments, China said talks with the U.S. accounting
watchdog will continue.

Under the Holding Foreign Companies Accountable Act, the SEC started publishing a provisional list of companies identified as running afoul of requirements with the first
release in early March.

“The growing provision list is a reminder that there’s a risk” and a reminder to do a risk check, TH Capital analyst Tian X. Hou said in an interview, noting that as investors become more familiar with the delisting situation, they will realize this is a routine check by the SEC under the new rules.

Even at the best of times, auditors miss signs of trouble in the balance sheets of companies. They are a regulatory burden designed to ensure companies follow the rules and yet whenever a crisis develops, the conflict-of-interest argument arises because auditors missed obvious transgressions.

Almost 80% of the Chinese economy has been affected in some way by the worst outbreak of Covid-19 in two years, straining the supply of commodities and posing an increasing threat to demand.

China’s restrictions to contain the fast-spreading omicron variant have primarily hit travel over both short and long-distances, which is a direct drag on fuel consumption and a complication for supply chains.

The longer that Beijing persists with its Covid Zero policy, the greater the impact will be on the consumption of commodities as purchases are deferred -- think copper for electronic goods or steel for cars. Production is also at risk as inventories of raw materials dwindle and workers stay at home.

Widespread outages at metals processors, for example, could further lift markets that have already hit record highs in recent weeks because of the war in Ukraine. That would set the inflation-hawks at the central bank and economic planning agency on edge. Still, demand is also likely to shrink at some point, which would leave the net impact on prices uncertain.

The coronavirus might be a medical issue, but pandemics are political. That is truer for China than most countries. They were the first country to experience it and adopted one of the most stringent quarantine regimes. That successfully contained the infection rate. Factories and ports remained open in 2020 because the problem was contained to Wuhan and the surrounding area.

In a brief statement carried by state media, China’s top financial policy body vowed to ensure stability in capital markets, support overseas stock listings, resolve risks around property developers and complete the crackdown on Big Tech “as soon as possible.” Yi Gang, governor of the People’s Bank of China, followed with a statement saying the central bank would help implement the policies, as did the banking watchdog.

While the pledges from President Xi Jinping’s government offered little clarity over what authorities may do to achieve their goals, it was the first time China publicly addressed investors’ top concerns in one coordinated swoop. The move underscored Xi’s focus on ensuring economic and financial stability before a Communist Party congress at which he’s expected to secure at least another five years in power.

By the time trading ended just after 4 p.m. local time on Wednesday, the Hang Seng China Enterprises Index was up 12.5% in its best session since October 2008. Alibaba Group Holding Ltd. surged 27%, while JD.com Inc. jumped 36%. Property stocks rallied the most in more than a decade.

Investors have been fearful of buying Chinese securities because of uncertainty about the commitment of the government to do what is necessary to protect the economy. Now they have an answer, government officials do not like volatility and China’s stock markets have been falling in a very panicky manner. 

Saudi Arabia is in active talks with Beijing to price its some of its oil sales to China in yuan, people familiar with the matter said, a move that would dent the U.S. dollar's dominance of the global petroleum market and mark another shift by the world's top crude exporter toward Asia.

The talks with China over yuan-priced oil contracts have been off and on for six years but have accelerated this year as the Saudis have grown increasingly unhappy with decades-old U.S. security commitments to defend the kingdom, the people said.

The Saudis are angry over the U.S.'s lack of support for their intervention in the Yemen civil war, and over the Biden administration's attempt to strike a deal with Iran over its nuclear program. Saudi officials have said they were shocked by the precipitous U.S. withdrawal from Afghanistan last year.

China buys more than 25% of the oil that Saudi Arabia exports. If priced in yuan, those sales would boost the standing of China's currency.

Gold is a monetary metal because it is the barometer against which we can compare the performance of fiat currencies. However, gold stopped being a currency when President Nixon took the USA of the gold standard in 1971.

By 1973, the surge in oil revenues created an excess reserve issue for Gulf states and recycling savings into Treasuries made sense. That created the so-called petrodollar system. Since oil is used in every country in the world it is also used as a unit of account.

The Saudis are conducting due diligence and benchmarking the offer against others that Foxconn has made for similar projects globally, one of the people said.

Besides Saudi Arabia, Foxconn is also talking with the United Arab Emirates about potentially siting the project there, one of the people said.

The Taiwan-based company has looked to diversify its manufacturing sites amid rising tensions between China and the U.S. that put it in a potentially vulnerable spot.

Riyadh wants the company to guarantee that it would direct at least two-thirds of the foundry's production into Foxconn's existing supply chain, one of the people said, to ensure there are buyers for its products and the project is ultimately profitable.

Foxconn is seeking large incentives including financing, tax holidays and subsidies for power and water in exchange for helping set up a high-tech manufacturing sector in the kingdom, the people said, as Saudi Arabia seeks to diversify its economy away from oil.

The Saudis could offer direct equity co-investment, industrial development loans, low-interest debt from local banks and export credits to compete with other jurisdictions that Foxconn might consider, said another person familiar with the talks.

Saudi authorities and Foxconn didn't respond to requests for comment.

Pandemic exiles leaving Hong Kong brought COVID-19 with them to Shenzhen. The city and its environs have been locked down which is impacting the ability of component suppliers to perform at peak capacity.

Chinese tech giants like Alibaba Group Holding Ltd. and Tencent Holdings Ltd. in the past year. Beijing’s clampdown on private enterprise appeared to intensify in recent weeks after authorities required food delivery platforms to cut fees they charge restaurants and warned of risks in investing in products
linked to the metaverse.

Since its February 2021 peak, the China tech gauge has slumped nearly 60%. Adding to the fragile sentiment are concerns about a potential interest rate hike from the U.S. Federal Reserve next week and elevated commodity prices fueled by the war in Ukraine.
 
“Investors may be looking to sell growth names into the brief rallies to reduce their risk exposure, given multiple headwinds including Russia and the upcoming rate hikes,” said Vey-Sern Ling, a senior analyst at Union Bancaire Privee.

JD.com reported strong 2021 earnings but guidance was the share’s downfall today. This is a trend which troubled many US growth companies during earnings season as well. Keeping up pandemic era growth when liquidity is less available, and the real world is competing for attention versus screens, is a tall order. JD.com broke lower on the news.

Ukraine is open to discussing Russia’s demand of neutrality as long as it’s given security guarantees, though it won’t surrender a “single inch” of territory, a top foreign policy aide to President Volodymyr Zelenskiy said.

“Surely, we are ready for a diplomatic solution,” Ihor Zhovkva, Zelenskiy’s deputy chief of staff, said in an interview with Bloomberg Television on Wednesday. 

The aide reinforced Ukraine’s demand for security guarantees “from the U.S., from Great Britain, from Germany” and others -- “only security guarantees from Russia will not be enough,” though he declined to spell out what those measures would entail. 

Preconditions for talks with Russian President Vladimir Putin would be a cease-fire and the withdrawal of Russian troops, Zhovka said.

When the war is over, Ukraine is most likely to follow a Finland-type solution. They may apply for membership of the EU, but not NATO. They will receive security guarantees from their neighbours, but will need to retain a significant military and constant vigilance nonetheless. Relations with Russia will be irrevocably damaged and portions of Ukraine will likely become part of Russian territory. However, the fact remains many of Russia’s pipelines flow through Ukraine’s territory. Trading relationships will be necessary.

President Joe Biden said the U.S. will ban imports of Russian fossil fuels including oil, a major escalation of Western efforts to hobble Russia’s economy that will further strain global crude markets.

“We’re banning all imports of Russian oil and gas and energy,” Biden said Tuesday at the White House. “We will not be part of subsidizing Putin’s war.”

The U.S. move will be matched in part by the U.K., which will announce a ban on Russian oil imports on Tuesday, though it will continue to allow natural gas and coal from the country. Other European nations that rely more heavily on Russian fuels will not participate. The scope of Biden’s action was not immediately clear, including exceptions and the impact on shipments already in transit.

Biden’s move is a significant step in his sanctions campaign against Russia after its invasion of Ukraine. While so-called self-sanctioning by the oil industry has limited some purchases of Russian barrels, an outright U.S. ban would further weigh on the market and increase volatility.

If sanctions are to work, they need to hit the target where it hurts. If Russia is to be chastened, more of the world needs to stop buying its products. That’s going to come with massive dislocations to the global economy. It’s a necessary sacrifice because appeasement does not work.

“What China publishes as a target and what they actually aim to achieve are two separate things,” said Freya Beamish, head of macro research at TS Lombard. “The actual number will be published close to the target. But the reality could be significantly weaker.”

China’s economic links with Russia and Ukraine are a small part of its overall foreign trade and investment, so Beijing may calculate that it can largely insulate its economy from global instability, as it did during the global financial crisis and coronavirus pandemic.

“China has tended to capture larger shares of global trade when there are global problems,” Huang said. “They may have been lulled into a feeling that the Ukraine situation won’t hurt them.”

Beijing has pledged to accelerate fiscal spending without increasing debt by using unspent funds from previous years and state-owned enterprise profits. The funding from such sources mean the stimulus will be relatively small-scale.

“The government’s growth target is probably the upper edge of what China can reasonably achieve without large-scale stimulus,” said Adam Wolfe, an economist at Absolute Strategy Research in London. “It’s much more of a stretch target than last year’s.”

China’s growth target will need to be supplemented by liquidity provision if it is to be achieved. That’s particularly true given the macro background of undefinable ripple effects from cutting Russia off from Swift.

In 2020 I began a series of reviews of longer-term themes which will be updated going forward on the first Friday of every month. These reviews can be found via the search bar using the term “Secular Themes Review”.

When Wall Street indices were breaking out to new highs in 2012/13 the world looked to be on the cusp of a golden era of globalisation, co-operation, and the inevitable rise of the middle class. Higher living standards would breed a more tolerant society with greater respect for the environment and for our fellow global citizens.

In predicting a secular bull market, we were correct about the market call. Wall Street and the FANGMANT stocks have outperformed global indices by a wide margin over the last decade. It was also correct to expect oil to underperform because of the bounty arising from shale oil and gas. Predicting a decade ago that the USA would become energy independent was seen as maverick. Today it’s a fact.

The social upheaval that began with the monetary and regulatory response to the credit crisis represents a significant threat to the utopian ideal of the everyman. Exporting job security in return for cheap products has hollowed out the middle class in most developed countries. The evolution of the subscription business model has also reduced individuals to cash flows; where ownership of hard assets is marketed as an outdated concept. This has contributed to significant social upheaval and the response to the coronavirus pandemic amplified it.  

At the same time, the trend of geopolitical tension continues to rise. The concentration of wealth in the hands of a small number of people, companies and countries is creating greater competition. China is much more active in staking its claim to global trade than in the past and Russia’s current invasion of Ukraine is reflective of a desperate need for both security and relevance in a world that is actively working to use less of its primary export; oil.

Chinese technology shares had their worst two-day drop since July due to renewed fears Beijing may roll out more restrictions for private enterprise. Traders pointed to everything from regulatory warnings over the weekend about scams in the metaverse -- a virtual-reality based social media concept -- to unsubstantiated talk about more curbs on the gaming industry. Tencent is a leader in metaverse development.

On Monday, a screenshot detailing the alleged new gaming curbs made waves on China’s internet. But Wang Guanran, an analyst with Citic Securities, clarified that the content was originally posted by him last year when regulators hosted study sessions on gaming regulations.

“I didn’t post anything today,” he said on his WeChat. The screenshot flagged more oversight of violent genres and concepts like anime and religion and limits on player spending on loot boxes.

Protestations that Tencent does not expect additional curbs on its primary business lines would be more convincing if the government were not asking banks to disclose their relationships with Alibaba’s ANT Financial. 

The Winter Games are of course Xi’s prestige project, so the administration is going to incredible lengths to make the event a success. While the competitors will be isolated from the local population, continuing the effort after the Games are over makes little sense. City-wide lockdowns are unlikely to work against a variant as infectious as Omicron. This is evident in Hong Kong, where the outbreak looks increasingly serious. Yet the cost of zero-COVID is rising every day as the city is cut off from the rest of the world, and even from China.

Hong Kong highlights the wider challenge Omicron represents for Xi. He tried to impose total control but failed. As Omicron spreads, opposition within the CPC will grow stronger. Xi’s carefully choreographed elevation to the level of Mao and Deng may never occur.

It is to be hoped that Xi may be replaced by someone less repressive at home and more peaceful abroad. This would remove the greatest threat that open societies face today. Their task is to do everything within their power to encourage China to move in the desired direction.

When state media is under total government control, nothing we hear about happens by mistake. It is worth remembering that when we assess what signals are being sent by China’s media.

The People’s Bank of China is catching its breath after it cut the one-year medium-term lending facility rate last month -- the pause won’t last long. The central bank has signaled it’s ready to deliver more support to prop up growth. We expect the next cut as soon as the second quarter, and see the PBOC delivering another one in 3Q -- part of a broader array of easing measures to counter the slowdown.--David Qu and Chang Shu, China economists

Despite the decision to hold the one-year policy loan rate steady Tuesday, the PBOC’s easing stance has set it apart from other major central banks including the Federal Reserve, which are tightening monetary policy to tame soaring inflation. The possibility that the Fed will accelerate the pace of rate hikes could restrict China’s room for further easing later this year as it could accelerate outflows. 

Global demand for Chinese bonds has already slipped amid their shrinking yield premium. The yield gap on China’s 10-year sovereign bonds over similar-maturity Treasuries narrowed to 73 basis points last week, the least since 2019.

China wishes to put an end to the pattern of booming asset prices every time it eases policy. The kneejerk reaction of Chinese investors has always been to rush into property when liquidity eases. It has been the best performing asset, but prices are now also very high and affordability is an issue.

China offered its huge steel industry five extra years of rising carbon emissions, sending iron ore soaring as investors saw the move as a renewed focus on propping up the economy.

Steelmaking accounts for about 15% of China’s carbon emissions. On Monday, the government set 2030 as the new deadline for peak-emissions for the sector, against an earlier target of 2025. That adds to signs that Beijing is recalibrating its climate strategy in light of last year’s commodity price spikes, and priming the economy for a more powerful, carbon-intensive stimulus. 
“This is a big adjustment to the timetable, which gives more room for the steel sector to reach peak emissions in an orderly way,” said Xu Xiangchun, an analyst with researcher Mysteel. A rush to meet carbon goals could lead to “unbearable economic costs”, he said.

The policy pivot is another sign that Beijing is changing the trajectory of its decarbonization plans to ensure industrial changes don’t result in damaging inflation or shortages. President Xi Jinping said last month that climate targets shouldn’t compromise supplies of commodities that “ensure the normal life of the masses.”

Iron ore surged past $150 a ton, with expectations rising for more infrastructure to soften China’s economic slowdown. More construction activity tends to means higher steel output, which in turn raises iron ore demand but means more greenhouse gases.

Xi Jinping announced a change of emphasis ahead of the Lunar New Year Holiday in saying carbon reduction would need to take a backseat to ensuring living standards are protected. Today, there was also news that the State investment fund is buying stocks to support prices and that curbs of property market loans are being removed. That’s all supportive of the view China is actively putting a floor under asset prices.

In 2020 I began a series of reviews of longer-term themes which will be updated going forward on the first Friday of every month. These reviews can be found via the search bar using the term “Secular Themes Review”.

The biggest trend in the world isn’t bitcoin or the FANGMAN stocks. It’s bonds. Yields peaked in 1980 and the cost of borrowing has done nothing but decline since.

That’s enabled the steady rise of leverage, debt accumulation, asset price appreciation, speculation in all manner of public and private assets and every other bull market too.

The exact mix of where the debts have accumulated most is different in each country. For the USA, fiscal excess and unfunded liabilities are the biggest debt issue. The large number of companies surviving with no profits is the second biggest debt issue.

In Australia, Canada and the UK, consumer debt ratios, household debt and property debt are the pain points. The Reserve Bank of Australia’s reluctance to raise rates, despite inflation, is a symptom of the economy’s reliance on property prices.

For China, the accumulation of debt in the property sector has been epic. The sector represents 30% of GDP. At least in Japan, the massive quantity of debt is held domestically but it is a significant hurdle to raising rates.

And having avoided the all-out stimulus of Western peers when the Coronavirus first struck in early 2020, the PBOC finds itself with dormant consumer prices and room to “open the monetary policy tool-box.”

For China, that sets the stage for a triple dose of support from increased lending, lower borrowing costs and — potentially — a weaker yuan that would boost exports. The PBOC has already made a down payment on rate cuts and most economists expect more to come.

By China’s normal standards, the prize for successful stimulus will be small — more preventing a continued slide in growth than driving a fresh acceleration. And past policy errors — allowing a debt bubble to expand to enormous size — add risk to the outlook and a constraint on the PBOC’s freedom of maneuver.

If Yi and his team can pull it off, though, the boost from PBOC stimulus should offset at least some of the drag on global growth from Fed tightening. International Monetary Fund projections show China is set to contribute more than one-quarter of the total increase in global gross domestic product in the five years through 2026, exceeding the U.S.’s roughly 19% share.

China avoided overstimulating the economy during the pandemic because they didn’t have to. Most factories have attached dormitories. That ensured production hummed even as much of the country was locked down. Instead, they used the massive surge in export revenue as catalyst to reshape the economy. Clamping down on property developer leverage and reshaping innovation priorities in the tech sector were top of the list.

Overseas investors boosted their holdings of Chinese sovereign bonds by 575.6 billion yuan ($90.9 billion) in 2021, the fastest pace on record compared with previous years, according to Bloomberg calculations of Chinabond data. 

Foreign exchange settlement under securities investment in the capital account, which reflects offshore investors’ buying of onshore equities and bonds, surged to $23 billion in December, the highest since records began in 2010.

Ken Cheung, chief Asian FX strategist at Mizuho Bank Ltd., said the high returns of yuan-denominated assets and the stability of the yuan exchange rate are attractive to foreign capital. 

However, the narrowing U.S.-China yield spread will lead to slower inflows into the onshore bond market, and direct investment next year could ease, considering multiple factors, including regulations, U.S.-China relations and China’s slowing economy, Cheung said.

The Renminbi has been slowly appreciating versus the Dollar since early 2021. That reticence of the Chinese government to deploy massive monetary and fiscal stimulus during the pandemic have contributed to the strength of the currency and the relative attraction of Renminbi bonds.

The Hang Seng Tech Index jumped 4.5%, with Meituan and Tencent Holdings among those leading gains. The gauge has started 2022 with an advance after losing about a third of its value last year amid Beijing’s clampdown on tech companies. 

The rally followed clarification from China’s internet regulator late Wednesday that it’s not asking to approve all investments or fundraising by big tech companies, denying an earlier media report.  

A Bloomberg Intelligence gauge of Chinese real estate developers advanced 3.6%, following reports that the government may ease access to some funds. The sector’s gains came even as Thursday’s cut in the five-year loan prime rate left some market watchers disappointed.    

Shares of Country Garden Services Holdings Co. and Sunac China Holdings Ltd. surged more than 10% each. The unwinding of some short positions also likely aided the rally in property stocks, traders said.  

Agile Group, Shimao Group and Guangzhou R&F have about 20% of their free-float shares sold short, among the highest in the MSCI Asia Pacific Index, according to data from IHS Markit. 

Chinese New Year is on February 1st and will be followed by a week-long holiday for mainland markets. At the same time the winter Olympics begins on the 4th which will focus the sporting media’s attention on Beijing. The central bank is making sure its messaging is clear ahead of the shutdown. That’s also aimed at instilling some confidence in investors that the squeeze on private property developers will be limited to that sector.

“Consumption remains the weakest link in China’s growth story at the moment and that will by and large continue for much of this year,” said Louis Kuijs, head of Asia economics at Oxford Economics. “We think Beijing has a bottom line of around 5%. As is the case at the moment, if growth is weaker than that, they’d feel strongly motivated to pursue more policy easing.”

Economists expect more policy action from the PBOC in coming months. Goldman Sachs Group Inc. said there’s a possibility the central bank will allow banks to lower the five-year loan prime rate, a reference for mortgages, on Thursday. The one-year rate was already cut in December. Economists at Australia & New Zealand Banking Group and BNP Paribas see the likelihood of further reductions in the reserve requirement ratio for banks.   

The big question for liquidity dependent stocks is where the next big source of liquidity is going to come from. The US government is struggling to get additional spending measures passed. The Fed expects to be done with QE tapering in a couple of months and both Europe and Japan are not significantly increasing their programs. The potential for China to do more to support flagging growth is one of the few realistic possibilities for ample additional liquidity in the near term.

A link to the full report is posted in the Subscriber's Area.

Capital is both global and mobile. China demurred from opening the monetary and fiscal spigot during the early portion of the pandemic. It didn’t need to. Demand for its exports took off and it was possible to keep factories open because of the country’s strict quarantine regime. Using a period of outsized growth in its balance of trade to tighten up on overleverage in the property sector was a sound countercyclical policy.

The Nasdaq Golden Dragon China Index rallied 9.4%, its largest climb since 2008. Electric-vehicle maker Nio Inc. and Tencent Music Entertainment Group were among some of the best performers Thursday, climbing 15% each. Alibaba Group Holding rose 9.7%, while Tal Education Group advanced 15%.

“It’s finally time to buy Chinese equities,” Vital Knowledge analyst Adam Crisafulli wrote in a research note. The Nasdaq Golden Dragon China Index is back at levels that have acted as solid support going back over the last several years, he said.

U.S.-listed Chinese stocks have experienced a brutal selloff in 2021 as regulators in Beijing mounted a sweeping crackdown on the nation’s companies. That rout erased more than $1 trillion in value since February as authorities in the U.S. and China continued to put pressure on the firms. Despite Thursday’s rally, the group is still down about 42% this year and about 57% lower from its February peak.

The Golden Dragon China Index had a dismal 2021. It was dragged lower by fears of nationalisation of China’s champion companies, the equivalent of a seismic event in the regulatory environment and the threat of shares needing to delist from US exchanges. That all occurred against a troubling backdrop of deteriorating sentiment that the trade war will ever end.

Equity team co-heads Atul Narayan and Erin Miles on other equity markets catching up with the US: Looking ahead, it feels that things are primed for the equity markets that have lagged the US (China, Japan, the UK, Europe, etc.) to catch up. There are several factors at play. First, COVID has been a material relative support to US equities from all channels—favorable sector tilt, less virus economic impact, more support from falling rates (versus, say, Japan, where yields are pegged), and compressing risk premiums, given safe-haven appeal for US equities, especially the FAANMGs. We would expect the COVID impact to gradually fade in the coming year and this to be a relative support for the markets outside the US.

Second, China is showing early signs of moving toward easing after a year when the structural goals (deleveraging, rebalancing, common prosperity, etc.) were prioritized. This again will be a bigger relative support for economies like Japan, Europe, and EMs that are a lot more exposed to China. Finally, if you look back over the last 100 years, it’s almost always been the case that the winners of a given decade end up being laggards in the next one because of the degree of exuberance (and pessimism) that gets priced in following the winning (and losing) stretch. Given how stretched the relative positioning and pricing is today (for logical reasons), we expect the US versus rest of world diff to finally start to revert after a decade-long off-the-charts performance. The main things we are watching closely are the evolution of COVID globally, China’s policy stance, and the retail flows in the US, which were the biggest support for US equities over the past year and a half.  

Based on valuations alone, there is a strong risk-adjusted argument for favouring ex-US assets. I also find the argument that a recovery for China’s economy would have a more positive effect on the Ex-US basket to be reasonable. However, momentum remains a tailwind for Wall Street which has been supported by the relative strength of the Dollar all year.

While much is still unknown about how Sinovac’s shot holds up to omicron -- including how T cells, the immune system’s weapon against virus-infected cells, will respond -- the initial results are a blow to those who have received CoronaVac. There have been more than 2.3 billion doses of the shot produced and shipped out, mostly in China and the developing world. 

With omicron seen to be about 70 times more transmissible than the delta variant, the prospect of having to roll out different boosters or even re-vaccinate with a more omicron-specific vaccine will set back the world’s efforts to exit the pandemic.

Evidence has been emerging for months that the primary Chinese made vaccines are ineffective against variants like Delta or Omicron. This article from Reuters focuses on China’s lockdown of Xi’an but highlights that none of the 200 cases found to date are from the Omicron variant. That suggests it is only a matter of time before the newer variant arrives despite the already strict measures to contain the threat already in place.

Developers on mainland and Hong Kong bourses have diverged in recent weeks, with typically stronger firms listed in Shanghai and Shenzhen outperforming. A move by authorities encouraging lenders to fund acquisitions of projects held by distressed developers may benefit larger, often state-owned firms most. A Bloomberg Intelligence gauge of Chinese property companies mostly traded in Hong Kong closed on Monday near a five-year low before rising 3.4% on Tuesday.

The most likely scenario is many of the private property developers are going to be taken over by state-owned companies. Since that is the most likely result, the state-owned sector will be the primary beneficiary of the rationalisation of the property developers’ sector. 

The weakening of retail sales surprised analysts who were expecting a boost from the annual online “Singles Day” shopping festival. Spending in the restaurant and catering sector fell year-on-year in November, while car sales dropped for a fifth straight month. 

China has been facing persistent outbreaks of the delta-variant and recorded its first cases of the more-contagious omicron variant this week, adding to pressure on authorities to implement local lockdowns.

What Bloomberg Economics Says...
China’s November activity data suggest the economy is still under strain, though the production side appears to be stabilizing. The pressure on the demand side was clear, with growth in both fixed-asset investment and retail sales extending slowdowns. We expect fiscal and monetary policies to become more supportive in the months ahead.

The central bank refrained from easing monetary policy on Wednesday. It kept the interest rate for one-year loans to banks unchanged and only rolled over about half of the maturing debts, withdrawing liquidity from the banking system. A recently announced cut to the reserve requirement ratio for banks takes effect from Wednesday, which should make it cheaper for them to extend new loans.

There was limited reaction in financial markets to the data. The CSI 300 Index was down 0.6% as of 1:45 p.m. in Shanghai. The yield on 10-year government bonds was flat at 2.88% and the yuan strengthened less than 0.1% to 6.3644 per dollar.

A weak labor market further worsened the outlook for consumer spending. The surveyed jobless rate inched up to 5% while the average number of hours worked per week fell slightly from the previous month.

“Domestic consumption remains weak with retail sales disappointing,” said Raymond Yeung, chief economist for Greater China at Australia & New Zealand Banking Group Ltd. “The incremental increase in the jobless rate is concerning. The authorities should pledge more support and offer a stronger signal to the market.”

The contrast between China and the rest of the world is growing increasingly stark. The demand surge during the pandemic has not yet ebbed in much of the rest of the world but is quickly receding in China. The key variable is liquidity. The USA and Europe spent inordinate sums to support their economies. China clamped down on personal freedoms and did what was necessary to ensure factories were operational, but did not engage in anywhere near the same level of monetary and fiscal accommodation.

While Evergrande bondholders face deep haircuts in a restructuring that could take months or even years to resolve, there were few signs of financial contagion on Thursday. That’s partly because investors had been anticipating a default for months, but also thanks to a flurry of activity by China’s government to cushion the blow.

Policy makers have in recent weeks cut lenders’ reserve requirements, signaled an easing of real estate curbs and rolled out measures to ensure higher-rated developers retain access to funding. They’ve also taken a leading role in Evergrande’s restructuring, appointing officials from the developer’s home province to help oversee the process. 

While that’s likely to help prevent nightmare scenarios of an uncontrolled Evergrande collapse, authorities have made it clear they have no intention of bailing out the property empire started by billionaire Hui Ka Yan 25 years ago. In a pre-recorded video message at a seminar in Hong Kong on Thursday, People’s Bank of China Governor Yi Gang described Evergrande’s situation as a market event that should be dealt with in a market-oriented way. 

The Shenzhen-based developer, which disclosed more than $300 billion of total liabilities as of June, said in a brief exchange filing on Dec. 3 that it will “actively engage” with offshore creditors on a restructuring plan. But with Chinese authorities now calling the shots, the developer has stayed largely silent on details of what its restructuring might look like. 

Even Fitch has struggled to get information from Evergrande, noting on Thursday that the developer didn’t respond to its request for confirmation on this week’s coupon payments. “We are therefore assuming they were not paid,” Fitch analysts wrote in a statement. Bloomberg reported earlier this week that bondholders hadn’t received the money.

The long-expected default of China Evergrande is now underway and was preceded by the Kaisa’s default. Aoyuan’s difficulties are now also making headlines. Against a background of sensationalist media coverage, the Chinese administration is making enough liquidity available to support the wider property sector. They are also engaging in a forensic audit of local government off balance sheet vehicles to find out just how big the problem is.

Gundlach, 62, said the reason why Fed Chair Jerome Powell characterizes the economy as strong, but not strong enough to allow for a rate hike at this point, is that the underlying condition is in fact weak -- artificially propped up by an unprecedented degree of stimulus.

Here are some other takeaways from Gundlach’s remarks:
He focused heavily on inflation, saying the annual pace of gains in the consumer price index could hit 7% in the next month or two. He ran through numerous inflation measures and pointed out that shelter costs have climbed significantly. He also said it’s possible that the CPI inflation gauge won’t drop below 4% throughout 2022.

Markets could face more volatility now that the Fed has said it might quicken its tapering program.

Gundlach reiterated that he bought European stocks for the first time in 12 years, which he disclosed a few months ago. He still owns some of those and they’ve done just OK until recently. He didn’t own emerging-markets equities, though he envisioned a scenario when they might outperform U.S. firms. “We’re looking for major opportunities” and emerging markets could be one over the next few years, he said.

The dollar has been in structural decline since 1985, he said, reiterating that the twin-deficit problem (that’s the current-account gap and the federal budget deficit) will cause the greenback to fall over time, which bodes well for emerging markets.

I’ve been saying for most of this year that the Dollar is the lynchpin for a migration away from US Dollar assets. Wall Street has outperformed by a wide margin from the perspective of international investors since 2008.

A year ago, I began a series of reviews of longer-term themes which will be updated going forward on the first Monday every month. The last was on October 1st. These reviews can be found via the search bar using the term “Secular Themes Review”.

One of the most basic truisms in the financial markets is it is easier to make money in a bull market. The bull market that began in late 2008 and early 2009 has been liquidity fuelled. That was not obvious to everyone a decade ago but now everyone gets the message. Money printing inflates asset prices. As long as central banks are printing, we will have bull markets and the most speculative assets will perform best.

Companies currently listed in the U.S. and Hong Kong that use VIEs would need to make adjustments so their ownership structures are more transparent in regulatory reviews, especially in sectors off limits for foreign investment, the people said. It’s unclear if that would mean a revamp of shareholders or, more drastically, a delisting of the most sensitive firms -- moves that could revive fears of a decoupling between China and the U.S. in areas like technology. Details of the proposed rules are still being discussed and could change.

The overhaul would represent one of Beijing’s biggest steps to crack down on overseas listings following the New York IPO of ride-hailing giant Didi Global Inc., which proceeded despite regulatory concerns. Authorities have since moved swiftly to halt the flood of firms seeking to go public in the U.S., shuttering a path that’s generated billions of dollars for technology firms and their Wall Street backers.

It’s all part of a yearlong campaign to curb the breakneck growth of China’s internet sector and what Beijing has termed a “reckless” expansion of private capital. Banning VIEs from foreign listings would close a gap that’s been used for two decades by technology giants from Alibaba Group Holding Ltd. To Tencent Holdings Ltd. to sidestep restrictions on foreign investment and list offshore. It potentially thwarts the ambitions of firms like ByteDance Ltd. contemplating going public outside the mainland.
 

The era of China’s “don’t ask, don’t tell” regulation of the equity market is over. The government has been suspicious of the ease with which companies were raising capital overseas for years. The most particular concern is that foreign interests are gaining control of boards and companies are too independent from government oversight. That’s particularly true as plans become more ambitious and require national focus. Didi’s sneak listing, while regulators were away from the office, brought the issue to a head.

Jiang is also widely credited with authoring the 2014 Chinese-government white paper that gives Beijing “comprehensive jurisdiction” over Hong Kong. In a nod to Schmitt, the paper claims that the preservation of sovereignty—of “one country”—must take precedence over civil liberties—of “two systems.” Using Schmitt’s rationale, he raises the stakes of inaction in Hong Kong insurmountably high: No longer a liberal transgression, the security law becomes an existential

Chen and Jiang are “the most concrete expression thus far of [China’s] post-1990s turn to Schmittian ideas,” Ryan Mitchell, a law professor at the Chinese University of Hong Kong, wrote in a paper in July. They are the vanguard of the statist movement, which supplies the rationale for the authoritarian impulses of China’s leaders. And though it is unclear precisely how powerful they are in the upper echelons of the party, these statists share the same outlook as their paramount leader. “Xi Jinping’s big project is on reinventing and revitalizing state capacity,” Jude Blanchette, China chair at the Center for Strategic and International Studies, told me. “He is a statist.”

Why has a Nazi thinker garnered such a lively reception in China? To some degree, it is a matter of convenience. “Schmitt serves certain purposes that Marxism should have done, but can no longer do,” Haig Patapan, a politics professor at Griffith University in Australia who has written on Schmitt’s reception in China, told me. Schmitt gives pro-Beijing scholars an opportunity to anchor the party’s legitimacy on more primal forces—nationalism and external enemies—rather than the timeworn notion of class struggle.

It has been apparent for years that China is increasingly adopting a fascist doctrine of state supremacy. In just the same way that Nazi Germany was a rule by law society, China is emulating that progression.

“The Communist Party is celebrating its 100th year — so is JPMorgan,” the bank’s chief executive officer, Jamie Dimon, said Tuesday at a panel discussion at the Boston College Chief Executives Club. “I’d make a bet we last longer,” reported Bloomberg News. 

And

In China, business dealings often come down to narrative. One day, a foreign bank is welcome, and its presence is seen as helping China improve its financial industry. The next day, the same enterprise could be painted as a predatory vulture. Words matter, and harmless intent or humor can be misconstrued in translation. Jamie Dimon has every right to tell a joke, but it always helps to know your audience.

The longevity and persistence of the Party are not topics of conversation in China. Jamie Dimon may as well have been using cartoons of the Prophet Mohammed in his PowerPoint. That’s the closest parallel for the gaffe committed yesterday. It is reasonable to expect JPMorgan’s prospective Chinese private banking clients to think twice before the starting a relationship. Retribution may not happen immediately but it will come.

However, Lenovo actually derailed from the route of trade, industry and technology. Instead of making real efforts to scientific and technological innovation after original accumulation, it gradually withdrew from the front line of national scientific and technological progress, and made fewer contributions to China's core competitiveness. Many people felt that this failed to live up to their expectations on Lenovo as a well-established enterprise.

In particular, it has been eclipsed by tech companies such as Huawei that have suffered from US crackdown, and was not as innovative in patterns compared with emerging companies such as Xiaomi. But Liu and Yang, and their likes still enjoy a high salary of hundreds of millions of yuan in the partially state-owned enterprise. As a result, both the public image of the whole company and their own personal images have become fragile. In fact, doubts emerged a long time ago.

Calling out a publicly owned company for its failure to live up to its responsibility to the state’s expectations is a warning shot from the perspective of investors in the share.

Revenue growth at a plethora of divisions including its Cainiao logistics arm and local on-demand services underperformed expectations, while bread-and-butter customer management revenue from platforms like Taobao and Tmall grew just 3% -- the slowest in at least five quarters.

Competition is intensifying just as China grapples with the widest Covid-19 outbreak since the virus first emerged in Wuhan. Rivals like JD.com Inc. and Pinduoduo Inc. are stepping up investments to win over Alibaba’s users, just as a resurgence in coronavirus cases dents consumer spending. Gross domestic product expanded 4.9% in the September quarter, cooling from the 7.9% growth in the previous period, partly because of lockdown measures across many cities.

“Looking ahead, we will continue to invest heavily into three growth engines of domestic consumption, globalization, cloud computing and data intelligence,” Zhang told analysts on the call.

China’s growth has slowed meaningfully as the housing market shock therapy imposed in response to Evergrande’s overleverage has weighed on sentiment. As more credit is made available to property developers, speculative interest should begin to recovery over coming quarters.

“India is on a 50-year rally,” even if there are short bouts of bear markets, Mobius said in an interview on Bloomberg Television. “India is maybe where China used to be 10 years ago,” he said, adding the government policies of unifying rules across states will help the country in the long run.

Mobius’ bullish view on India clashes with those of analysts at Morgan Stanley and Nomura Holdings Inc., who have downgraded the stock market after the benchmark S&P BSE Sensex Index more than doubled from a March 2020 low.

Emerging-market equities have trailed behind their developed-nation peers this year, held back by losses in China as the government has roiled markets with a widespread regulatory crackdown.

“People say emerging-markets look bad because China is dragging down the index, but they have to look at other areas such as India that are going up,” said Mobius…

Saying that India could be on a 50-year bull market is not incompatible with the risk of a reversion towards the mean which would correct the short-term overvaluation.

India represents a significant growth opportunity but is also subject to volatility. The Nifty Index remains in a reasonably consistent uptrend but is best bought following inevitable occasional setbacks.

The producer price index climbed 13.5% from a year earlier, the fastest pace in 26 years and above economists’ median forecast for a 12.3% gain, data from the National Bureau of Statistics showed Wednesday. The consumer price index rose 1.5%, the highest since September 2020 and exceeding the projected 1.4% gain.

Producer prices in China have been rising rapidly in the past few months, first due to the global commodity price rally and then output curbs caused by a power crunch. Consumer inflation is also starting to pick up as weather-related supply problems push up food prices and manufacturers pass on higher costs to retailers. 

The data “implies broad-based inflation pressure on both the production side and the consumer side,” said Bruce Pang, head of macro and strategy research at China Renaissance Securities Hong Kong Ltd. “Inflationary pressure and the more hawkish stance of monetary policy in other major economies will likely limit China’s room to maneuver for monetary easing.”

China exported deflation for much of the last twenty years, with a steady flow of cheaply manufactured goods flooding the global market. That boosted consumption as well as created the impression prices would never again rise in an unexpected matter.

As stress among Chinese developers mounts, some firms are telegraphing their ability to meet debt
obligations.

On Monday, Zhenro Properties Group Ltd. said it informed a bond trustee it will redeem its 5.95% dollar notes early in full on Nov. 16. Central China Real Estate Ltd. on Tuesday said it has remitted funds to a trustee for payment of its 6.75% dollar bonds, which are due Nov. 8.

“Central China Real Estate becomes one of a string of developers publicly setting aside money to redeem offshore bonds in apparent attempts to set themselves apart from weaker firms,” said Daniel Fan, an analyst at Bloomberg Intelligence.

Property companies need to do all they can to restore investor faith. Yields on Chinese junk dollar bonds -- dominated by real estate firms -- surged to more than 20% on Monday, the highest in at least a decade. Credit assessors are downgrading the industry’s companies at the fastest pace on record. At least four developers defaulted last month and others sought to delay near-term bond payments as contagion sparked by China Evergrande Group spreads.

China’s property developers are in a fight for survival. Regardless of how leveraged or otherwise their business models are, they all require access to liquidity. That’s creating a rush to put distance between themselves and China Evergrande, which is in a state of terminal decline.

China’s bracing for a cold snap this week, with temperatures in some regions forecast to fall by as much as 15 degrees Celsius. Vegetable prices typically rise when the temperature drops in winter and supply is unable to catch up with increasing demand before the Lunar New Year holiday.

The Monday statement told local commerce departments to coordinate more to improve local and inter-provincial supply chains for vegetables and also to strengthen monitoring of the prices of key staples such as vegetables and meat. 

Major agricultural distributors were encouraged to sign long-term contracts with producers, while provinces in both southern and northern China were told to improve their vegetable reserve systems and also release meat and vegetables from the reserves in a timely manner to replenish supplies. 

The call to stock up on food comes less than two weeks after a different government department told companies not to hoard food. 

 

Food prices are rising everywhere and that is putting everyone on edge. The experience of empty supermarket shelves was isolated to only a few household items during the pandemic while supply of staples was relatively constant. We’re still eating the rice we bought in January 2020 as a precautionary measure for example. (The chocolate is long gone).

As inflation continues to develop in the economy, see below the incredible link between gold and CPI since the GFC.

Note how after the pandemic lows, gold front ran the potential risk of a rise in consumer prices and the entire precious metals market appreciated sharply.

It is important to remember that before recently peaking, gold had been going on a streak for two years already.

The metal was up more than 75% from August 2018 to August 2020 and even reached historical highs during this period.

Back then, with CPI around 1%, very few investors foresaw inflation as a risk to the economy. Now it is a real problem.

We think gold likely appreciated too quick and too fast becoming what some thought as an obvious trade.

Extreme sentiment probably explains the reason for its recent weakness after signaling way earlier than any other asset the possibility that an inflationary environment could be ahead of us.
We are now on the other side of this extreme.

 

I have a lot of sympathy with the view that gold ran ahead for almost two years so it was due a pause. We also know that medium-term corrections in gold can last up to 18 months so it is a good time to start looking at the sector again since the peak was in August 2020.

Chinese authorities told billionaire Hui Ka Yan to use his personal wealth to alleviate China Evergrande
Group’s deepening debt crisis, according to people familiar with the matter.

Beijing’s directive to the Evergrande founder came after his company missed an initial Sept. 23 deadline for a coupon payment on a dollar bond, said the people, asking not to be identified discussing a private matter. Local governments across China are monitoring Evergrande’s bank accounts to ensure company cash is used to complete unfinished housing projects and not diverted to pay creditors, the people said.

The demand that Hui tap his own fortune to pay Evergrande’s debt adds to signs that Beijing is reluctant to orchestrate a government rescue, even as the property giant’s crisis spreads to other developers and sours sentiment in the real estate market. Chinese President Xi Jinping has been cracking down on the billionaire class as part of his “common prosperity” campaign to reduce the country’s yawning wealth gap.

It’s unclear whether Hui’s fortune is big and liquid enough to make a sizable dent in Evergrande’s liabilities, which swelled to more than $300 billion as of June. The developer’s dollar bonds are trading at deep discounts to par value as investors brace for what could be one of China’s largest-ever
debt restructurings.

Bailing out troubled lenders during the credit crisis and letting their senior management walk away with golden handshakes helped to seed a populist backlash against the status quo in the USA. That was exacerbated by a foreclosure crisis that saw millions of people kicked out of their homes. China appears to have learned from that mistake and Hui Ka Yan is unlikely to escape Evergrande’s dissolution unscathed.

The property controls have achieved good results and the government will refrain from using the real estate sector as a short-term economic stimulus measure, Liu Zhongrui, an official at the China Banking and Insurance Regulatory Commission, said at a briefing in Beijing on Thursday. Evergrande is an “individual” case and won’t hurt the overall credibility of Chinese firms, which is backed by the country’s economic stability, he said.

Property controls to stamp out speculation in the housing market have weighed on the country’s indebted developers, which are now seeing sales plunge and home prices snapping a years-long streak of increases. While officials have told banks to speed up mortgage lending again, the central bank has indicated that contagion risks from Evergrande are “controllable” and unlikely to spread.

Property lending growth at Chinese banks slowed to 8.6% this year through September, Wang Zhaodi, a spokesman at the CBIRC, said. That’s down from 12% in the first quarter, which was the slowest pace in eight years.

New-home prices in 70 cities fell 0.08% in September, the first drop in six years, official data showed this week, posing a potentially big blow for an economy that counts on property-related industries for almost a quarter of its output.

China Evergrande was ordered not to default on its US Dollar debt, so it has made a last-minute payment to avoid that outcome this weekend. It has late payment deadlines on two additional bonds due before the end of the month. Since it has so far failed to reach agreements on asset sales, it begs the question how long more can this go on for?

There are “individual problems” in the real estate market, but the risks are controllable overall, Vice Premier Liu He said at the same event, according to the official Xinhua News Agency. Reasonable funding needs in the sector are being met, Liu was quoted as saying.

Some analysts expect the current real estate slump to be less harsh than previous ones because inventories remain relatively small. Developers have been more rational about building projects in coastal cities where demand is higher, said Chen Long, a partner at Beijing-based consultancy Plenum.

“The relatively low stock of unsold housing limits the risk of a major downturn,” Oxford Economics said in a note on Wednesday. “We think the most likely scenario is a contained short-term downturn.”

Still, any recovery will be difficult until home values resume rising. 

“If property prices stop growing, we won’t buy,” said Jack, a tech worker in Shenzhen who didn’t want to be identified by his surname for fear of reprisals from his company. “Right now, I’ll sit and watch.”

The Federal Reserve is sensitive to equity prices because it is the most favoured asset class of US citizens. For the same reason the ECB is more concerned with bond prices than other asset classes. In China the vast majority of savers have some exposure to property prices so it is reasonable to ask how much pain can the government tolerate before they bend to market pressure?

A link to the full report is posted in the Subscriber's Area. 

Every country had to break the piggy bank to deal with the pandemic. That helped to boost economic activity and demand for just about everything over the last 18 months. Going back to less profligate ways will be a challenge everywhere, but emerging markets have the benefit of growth to ease the challenge. They also have more recent experience of doing what is necessary to combat inflation which should be a useful skillset going forwards.

Zou also said:

China’s government has insisted that property not be used as a short-term stimulus for the economy
Cities have seen an excessive surge in property prices, which mortgage restrictions helped to curtail
Property investment has slumped recently after some developers faced credit problems, but this is a normal market phenomenon
Some banks have misunderstood macroprudential policies regarding the property sector.

“This is the strongest signal yet that authorities won’t come to the rescue of creditors of Evergrande and other developers,” said Travis Lundy, a special situations analyst who publishes on Smartkarma. They are sticking to the stance that there won’t be any property-boosting measures, aside from small steps such as faster home-loan processing and efforts to alleviate mortgage limits at banks, he added. 

Financial regulators have told some major banks to accelerate approval of mortgages in the last quarter, Bloomberg reported earlier Friday. Lenders were also permitted to apply to sell securities backed by residential mortgages to free up loan quotas, easing a ban imposed early this year, according to people familiar with the matter.

It’s ironic that when China talks about market principles it means they are no longer willing to bailout failed ventures but are more than willing to curtail growth in successful ones; that do not gel with policy. The number of defaults has been trending higher since they were allowed a few years ago, and will surge this year.

Bonds fell after the central bank withdrew a net 190 billion yuan ($29.5 billion) of short-term funds from the banking system Monday after draining the most since January on Friday. The likelihood of a rate cut in the near term is low and the timing of a reduction in the reserve requirement ratio is uncertain, state-backed China Securities Journal said.

China’s benchmark 10-year yields climbed five basis points to 2.95% on Monday, the highest close since July. 

The jump in 10-year yields sent them out of the 10-basis-point range where they had been since the start of August, suggesting traders are giving up bets on aggressive monetary easing. The selloff also followed losses in other global bond markets amid a surge in inflation expectations due to rising energy prices and central-bank progress toward normalization.

The selloff is far from over, analysts at Guotai Junan Securities Co. led by Qin Han in Shanghai wrote in a research note. “All the factors, apart from weak economic growth, are negative for the bond market. The adjustment in China’s bond yields in the fourth quarter may be more drastic than expected.”

The PBoC actively supplied funds to the banking system ahead of the mid-Autumn festival holiday. That helped to allay fears of outright contagion to the wider market and supported the view the administration is fully aware of the risks the property market slowdown entails. By taking some of that money back out, the PBoC is trying to signal they have no intention of bailing out the whole world, like they did following the credit crisis. They might not have a choice. 

A reason for the price increase in lumber is a modest increase in renovation demand after price-sensitive buyers proceeded with home improvement projects now that wood prices have seen a substantial correction, Dustin Jalbert, senior economist at Fastmarkets, told Insider.

Though Jalbert does not expect the kind of runup in lumber prices seen earlier this year - a period when there was a backlog of homes waiting to be built and a shortage of key construction supplies - as pandemic-related supply constraints continued to ease.

"The market has finally transitioned to a more balanced state compared with being severely oversupplied in the summer months, which ultimately drove the massive correction in prices from record-high levels set in May," Jalbert told Insider.

And even if Americans wanted to build and renovate homes, the field consumption of lumber is being bogged down by shortages of other complementary materials such as windows, siding, cabinet appliances, and garage doors, he added.

The supply side, meanwhile, continues to face challenges, Jalbert said. Log costs in British Columbia, which accounts for about 16% of North American lumber capacity, remain elevated.

Commodities tend to remain in well-defined ranges for years before breaking out and rallying in a profound manner that creates an uncomfortable feeling for consumers and sets new price expectations for sellers. Lumber spiked higher between 1991 and 1993. It subsequently gave up most of the advance but never dropped back into the preceding range.

The U.S. and China agreed Wednesday that President Joe Biden and President Xi Jinping would meet before the end of the year. It will be a virtual meeting and follows a call between the two leaders that was held in September -- that was their first in seven months.

The virtual summit was announced shortly after White House national security adviser Jake Sullivan met a senior Chinese foreign policy advisor, Yang Jiechi, in Zurich, according to The Wall Street Journal.

"While we expect minimal material improvement in the tone or substance of their relationship in the coming months, we still see investment opportunities on both sides, especially in the areas of capital markets, technology, cybersecurity, and climate change," said strategists led by Mark Haefele, the chief investment officer at UBS Global Wealth Management.

"In our view, investors should avoid taking sides. The best long-term approach is to seek exposure to the different economic cycles, growth opportunities, and sectoral trends offered by both countries," the team at UBS said.

Strategists at the Swiss bank noted speculation around possible topics for discussion included trade, Taiwan, and climate issues.

Churchill’s “Jaw-Jaw is better than “War-War” comes to mind. It also begs the question whether the Biden administration is willing to make concessions on Taiwan’s independence for better trading conditions? That was certainly the case during the initial negotiations with China 50 years ago and not a lot has changed in terms of China’s priorities.

It looks like the government has blinked first. Miners, after months of being ordered to stick closely to capacity limits, are now being ordered to produce as much as they can, people familiar with the matter told Bloomberg News. That should help to take the wind out of surging thermal coal prices and prevent the current crisis from extending into the winter, when sufficient energy supply can be a life-or-death matter.

There is, to be sure, an attempt to make this retreat look like a withdrawal. The latest advice from Beijing’s economic planners last week focuses on protecting individuals but continuing the crackdown on industry, especially when it’s most energy-intensive and polluting. Allowing generators to raise prices to end-users, as is happening in Guangdong province, will also help create a more commercial power market. Electricity consumption controls have even been loosened in a way that would permit potentially unlimited volumes of cheaper renewable power into the market.

The risk, as with the rapidly fading fears over Evergrande, is that Beijing has simply deferred a pressing problem again. If China doesn’t reform a system that refuses to face up to its internal contradictions, the problems of an economy fed by credit and carbon will only fester and grow. 

 

Self sufficiency is Chinese government policy. Coal imports do not gel with that ambition so efforts to defray demand are likely to persist in a piecemeal manner subject to necessity. However, the reality is winters north of the Yangtze River are harsh and most communities rely on coal to heat homes, factories and run electricity.

On November 24th I began a series of reviews of longer-term themes which will be updated on the first Friday of every month going forward. The last was on May 7th. These reviews can be found via the search bar using the term “Secular Themes Review”

Supply Inelasticity Meets Rising Demand was the phrase David coined to explain the last commodity-led bull market. After decades of underinvestment in commodity supply infrastructure, the market was not prepared for the massive swell of new demand from China; as it leaped from economic obscurity into one of the largest economies in the world. A decade of investment in new production was needed to supply China and that crested ahead of the credit crisis in 2008.

Today, we also have extreme example of supply inelasticity, and demand is breaking records for all manner of goods and services. The factors contributing to these trends are quite different from a decade though. Some will be resolved relatively quickly. Others will take years.

The central bank has added a total net 750 billion yuan via open market operations since Sept. 17. When onshore markets reopen on Oct. 8, 340 billion yuan of 14-day reverse repurchase agreements will fall due. Later in the month, 500 billion yuan of medium-term lending facility is set to expire. 

Overnight interbank funding costs slid 43 basis points to 1.48%, the lowest since May, after the cash infusion. The seven-day repurchase rate, which covers the week-long break, rose 36 basis points to 2.55%, a level last reached at end-June. 

The injection is also expected to allay fears of a contagion stemming from Evergrande’s debt problems. In a bid to contain the fallout from the property developer’s woes, China has stepped in to buy a stake in a struggling regional bank from Evergrande.

“The purpose of liquidity injection is mainly to give market confidence amid the Evergrande crisis,” said Tommy Ong, managing director for treasury and markets at DBS Hong Kong Ltd. “Having said that, there is still a possibility of a RRR cut in October due to a slowdown in economic activities caused by supply constraints and slower export growth.”

Speculation of an easing comes after recent data indicated that the pace of expansion in the world’s second-largest economy is slowing. A power crisis is adding to the strain and economists from Goldman Sachs Group Inc. are among those who have slashed their growth projections for this year.

China’s 10-year sovereign bond yield fell one basis point to 2.86% on Wednesday. It sank to a 14-month low after the PBOC unleashed 1 trillion yuan of liquidity into the system via a reduction in the RRR in July. 

For China watchers, the big question over the last year was when would the credit cycle turn. It is looking increasingly likely that the China Evergrande default is the catalyst for additional infusions of liquidity that will likely last for at least the next year and potentially longer.

Dollar Tree said it plans to begin adding new price points above $1 across all Dollar Tree Plus stores.

To test additional price points above $1 in selected legacy Dollar Tree stores
On track in 2021 to have 500 Dollar Tree Plus stores by fiscal year-end
Another 1,500 stores are planned for fiscal 2022; at least 5,000 Dollar Tree Plus stores are expected by the end of fiscal 2024
Currently has 105 Combo Stores; expects to add 400 Combo Stores in fiscal 2022
Sees potential for up to 3,000 Combo Stores over the next several years

Rising shipping costs, power cuts in major manufacturing centres and rising commodity prices all point towards margin compression for the sellers of low-priced items. They have no choice than to pass that inflation along to customers. The temporary shutting down of port facilities outside Shanghai will also have had the knock-on effect of putting upward pressure on prices because so much manufacturing capacity of low-cost items comes from Zhejiang.

Invesco Solar ETF (TAN) falls as much as 6.5% intraday, the most since May 4, amid growing investor jitters about China’s real estate crackdown potentially sparking a financial contagion. 

Among individual stocks, JinkoSolar down as much as 10.6% during the session, Beam Global -9%, Daqo New Energy -10%, First Solar-9.3%, Canadian Solar -7.8%

China is by far the largest manufacturer of solar panels. Silica is a major component for the sector and production is being hampered by electricity supply disruptions. That’s taking a toll on the solar sector. At the same time the upward pressure on government bond yields threatens the business model of many domestic installation businesses.

Think, you may find interesting this Financial Times story that looks into the longer-term consequences of Evergrande saga - https://on.ft.com/3io45gH (open link). It seems that the Chinese real estate market finally (at long, long last) is crumbling, not without help of the country leaders. If it is so and given the fact that the property market accounts for 29% of the Chinese GDP (and land sales to developers, for the third of local governments’ revenues), the economic growth seems to slow dramatically in the coming years. What could be implications, in your view? We all remember that China and its industrialization were the major drivers of the global commodities supercycle in the 21st century. Also, every time China has got into trouble, the Communist party used the same recipe “more investments in infrastructure and construction, more leverage. If now China and its property sector grow much more slowly, not to mention possible contraction of the latter, it will need much less metals and materials, and also possibly less gas (to power plants and send it to homes) and even oil (fewer working trucks and construction equipment). What do you think?

Thank you for this informative email which may be of interest to the Collective. Here is a section from the FT article:

An even more consequential trend for China’s political economy is the collapse in land sales by local governments, which fell 90 per cent year on year in the first 12 days of September, official figures show. Such land sales generate about one-third of local government revenues, which in turn are used to help pay the principal and interest on some $8.4tn in debt issued by several thousand local government financing vehicles. LGFVs act as an often unseen dynamo for the broader economy; they raise capital through bond issuance that is then used to fund vast infrastructure projects.

The property market has funded local governments for decades. Without a solid trend of land sales municipal governments face bankruptcy. There is just no way the central government can let that happen. The first order solution will be to avert contagion into the rest of the property market following Evergrande’s demise.

Harvard Professor Ken Rogoff and Yuanchen Yang (now at the IMF), say Chinese property and construction amount to 29pc of GDP when all ancillary sectors are included. Housing makes up four fifths of personal wealth and land sales make 40pc of local government revenues.

They argue that this extreme dependence on the property nexus has not been tested because super-charged growth rates hide all sins. But China is no longer growing fast. Xi Jinping’s neo-Maoist ideology of “common prosperity” marks a profound break with the Deng Xiaoping catch-up model.

“We find that a 20pc fall in real estate activity could lead to a 5-10pc fall in GDP, even without amplification from a banking crisis, or accounting for the importance of real estate as collateral,” they said.

The US Federal Reserve’s Ben Bernanke once famously said “we’ve never had a decline in house prices on a nationwide basis” and nothing had substantially changed. But it had changed. The national Case-Shiller index would soon fall by 36pc.

The Rogoff-Yang paper said nothing should be assumed in the case of China either. “Even the very cautious pragmatic Chinese regulators may not yet be fully anticipating the depth of the possible fall in China’s housing prices,” it said.

Deflating an economy that is so hyper-leveraged to property is going to take years and will be untidy. China will almost certainly avert a Minsky crisis but it may not avert a long grinding semi-slump that profoundly changes the world’s perception of the country.

This conclusion makes sense to me. We are probably at the peak of speculative interest in the Chinese property market. The Party understands that the property sector will represent a threat to its rule if there is a collapse but also if prices accelerate further from here. That suggests progressively more measures to reduce leverage in the system. At a minimum that implies smaller companies and less construction activity.

China’s central bank boosted its gross injection of short-term cash into the financial system after concern over a debt crisis at China Evergrande Group roiled global markets. 

The People’s Bank of China pumped 120 billion yuan ($18.6 billion) into the banking system through reverse repurchase agreements, resulting in a net injection of 90 billion yuan. That matches the amount seen on Friday, and was just below that of Saturday. Sentiment was also boosted after Evergrande’s onshore property unit said it plans to repay interest due Thursday on its local bonds. 

“The PBOC’s net injection is probably aimed at soothing nerves as the market worries about Evergrande,” said Eugene Leow, a senior rates strategist at DBS Bank Ltd. in Singapore. “While the aim may be to instill discipline, there is also a need to prevent contagion into the real economy or to other sectors.”

The need to calm market jitters is pressing amid losses in China-related equities worldwide over recent days amid concern over Evergrande’s debt woes. The benchmark CSI 300 Index fell as much as 1.9% Wednesday after the Hang Seng China Enterprises Index -- a gauge of Chinese shares traded in Hong Kong -- slid the most in two months on Monday. Losses came even as Wall Street analysts sought to reassure investors that Evergrande won’t lead to a Lehman moment.

Any way we look at it, China will need to print more money. If the Evergrande issue is resolved through restructuring in a timely manner it will be less. If the issue is fudged and the hit to the economy is deep, it will be more. Following the announcement that a domestic bond coupon will be paid, there is only one question. What about international investors?

A link to the full report is posted in the Subscriber's Area. 

If the base case is that the company is bankrupt the question is how much contagion is likely to be experienced. Many property developer stocks have already pulled back in an extremely dynamic manner but not all will go bust.

The response so far has been largely limited to the People’s Bank of China, which injected a net 90 billion yuan into the banking system on Friday. It added another 100 billion yuan on Saturday.

Evergrande has around $300 billion worth of liabilities, more than any other property developer in the world. It’s a whale in China’s high-yield dollar bond market, accounting for about 16% of outstanding notes. Some $83.5 million of interest on a five-year dollar bond comes due Thursday, and failure to pay within 30 days may constitute a default. Evergrande also needs to pay a 232 million yuan ($36 million) coupon on an onshore bond the same day.

Evergrande’s shares lost as much as 19% on Monday, briefly taking its market value to the lowest on record. The stock closed 10% lower.

“With policy makers showing no signs of wavering on property market deleveraging, the latest headlines regarding Evergrande likely suggest that housing activity may deteriorate further in the absence of the government providing a clear path toward an eventual resolution,” Goldman economists led by Hui Shan wrote in a Sunday note.

The world is finally waking up to the contagion risk represented by China Evergrande. The big question which still needs to be addressed is who owns the company’s debt. Most of the $300 billion in US Dollar bonds were sold to international investors, while there is also an undisclosed sum in off balance sheet liabilities.

The growing importance of the environment in Beijing’s policy mix has left commodities markets caught between decelerations in both supply and demand. Iron ore prices more than halved between mid-May and mid-September as the steel production limits slashed demand for the steel-making ingredient. Aluminum, meanwhile, has jumped 46% so far this year as Chinese production -- more than half the world’s total --  of the energy-intensive metal is cut. The curbs on coal are particularly eye-catching because China has been wrestling with an unprecedented spike in the cost of the fuel. Coal futures in Zhengzhou hit a record in September, defying what should be a seasonal slowdown in demand. Any further cutbacks on output would run counter to the government’s pledges to stabilize prices by encouraging more domestic supply. It also would make another round of power rationing for industry more likely. Since coal is the major energy source in China for the production of fertilizer, its price has also soared.

The big question for many commodity investors is how serious is China about curtailing emissions? Perhaps a better question is how important is it to China’s leadership that the country look good ahead of the Winter Olympics in less than five months? Very important, is probably an understatement.

As there is still no indication of the regulatory crackdown, investing in the tech sector at this current juncture could result in a high risk of catching falling knives. On the flipside, the attractive valuation and rapid growth of these China Tech companies may strike as a good bargain to long-term investors. The sell-off of some tech stocks were not a result of any fundamental changes, but rather investor sentiment, which could change again in a flash. First, we must understand the short and long-term impact of the crackdown. Here are 3 fundamental factors you may want to consider if you decide to buy the dip:

1. Will policy changes cause structural change to business’s model?
2. Companies’ valuation
3. Companies’ growth

The big question for investors is whether the pullback in Chinese tech companies is just another short-term purge prior to re-establishing the prior growth trajectory or whether it represents deeper issues.

The PBOC is expected to conduct its monthly MLF operation on Wednesday, with 600 billion yuan due. Last week a central bank official said that interbank liquidity should remain balanced in the coming months, damping speculation that there’ll be another cut in the required reserve ratio soon. 

Money market traders are more cautious this month as cash demand could rise due to quarter-end regulatory checks and before China’s Golden Week holiday in early October. If the maturing MLF is not mostly rolled over or covered by another liquidity injection, market sentiment is likely to be further impacted, said Frances Cheung, rates strategist at Oversea-Chinese Banking Corp. 

Evergrande Woes
Concern about the property sector amid the potential restructuring of China Evergrande Group -- the world’s most indebted developer -- could also be impacting swap rates. 

Market participants might be preparing for “the liquidity squeeze in crisis mode,” Mizuho Bank Ltd. chief Asian FX strategist Ken Cheung wrote in a note.

“Rising property sector concerns and specific credit concerns around Evergrande are raising pressure on banks’ liquidity management,” Eddie Cheung, senior EM strategist at Credit Agricole, wrote in a note. He expects onshore yuan liquidity conditions to remain tight in the near term.

Over the May holiday weekend, Didi snuck through an IPO in the USA while the Chinese regulators were away from work. That allowed the original investors to divest of at least some of their position before the company is dissected. As we approach the Mid-Autumn Festival Golden Week festival, where everyone will be on vacation for a week. and the stock market will be shut, it seems like an ideal time for creditors to make a move on Evergrande.

Copper inventories extend a drop to the lowest level in almost 10 years, while aluminum holdings also fell and nickel inventories climbed, according to weekly data from Shanghai Futures Exchanges.

Copper -11% to 61,838 tons, lowest since Dec. 2011
Aluminum -1.6% to 228,529 tons, lowest since Dec.
Lead +3.3% to record 204,008 tons
Nickel +45% to 8,608 tons, following a more than 30% gain the previous week

The realisation that contagion risk in the property sector could bring down the whole economy has refocused the attention of the Chinese administration on easing up on liquidity tightening measures. That has helped to stabilise the high yield sector and is also helping to improve the outlook for industrial resources.

Hello Eoin, I really like your audios and try to listen to them almost every day and I find today's audio especially interesting because of your focus on Evergrande...and this is something I don't understand: how is it possible that a company of this size, being on the brink of bankruptcy, with a huge amount of USD debt (of which one can be sure it's on the books of big international players), keeps out of sight of the financial press...I can find almost nothing on this topic..and secondly: what do you think of the idea that the sudden drop of crypto was generated by the fact that Tether has usd evergrande bonds on its books...this seems to me a logical catalyst for this flash crash...

thank and keep up the good work...

Thank you for your kind words and this email which I believe will be of interest to the Collective. The reality is most journalists pay scant regard to the credit markets. On top of that writing negative, or cautionary, copy about China is dangerous for one’s career and particularly so if you happen to live in Hong Kong.    

On November 24th I began a series of reviews of longer-term themes which will be updated on the first Friday of every month going forward. The last was on May 7th. These reviews can be found via the search bar using the term “Secular Themes Review”.

If it walks like a duck and quacks like a duck, it must be a duck. Wall Street is behaving like it is in a bubble. The most important thing is the bubble is still inflating.

One of the company’s most widely held bonds plunged by 6 cents on the dollar to 28.5 cents on Wednesday, a record low. The rout -- triggered by Evergrande’s warning of a potential default if its asset-sale plans fail to materialize -- accelerated during European market hours as private banks offloaded positions, traders said.

The collateral damage was concentrated in junk-rated developers including Kaisa Group Holdings Ltd., Fantasia Holdings Group Co. and Guangzhou R&F Properties Co. The latter company’s dollar notes due 2024 tumbled 4.1 cents to 66.8, according to Bloomberg-compiled data. Declines in the broader Chinese high-yield space reached as much as 2 cents on the dollar, halting a tentative rally over the past few days. 

Investors in China’s $12 trillion bond market have become fixated on Evergrande as they weigh the ramifications of a potential default by the world’s most indebted developer. With bondholders, banks, suppliers and homebuyers exposed to the real estate giant, any collapse could roil China’s economy. While regulators urged the company to resolve its debt woes in a rare public rebuke earlier this month, they have said little about whether state support is forthcoming. President Xi Jinping has been trying to wean the Chinese financial system off implicit government guarantees that fueled years of outsized borrowing.

China Evergrande is the biggest issuer of US Dollar denominated debt in the emerging markets. The financial markets are floating on a sea of Dollars. There are so many dollars in circulation that cross currency swaps are close to moving into a positive spread for the first time in years. Therefore, Evergrande’s problems are not arising because global liquidity is tightening. Instead, they are the result of government efforts to contain leverage ratios in the Chinese property market.

Shares of Chinese liquor makers fall, with Kweichow Moutai and Wuliangye among the biggest drags on the benchmark CSI 300 Index.

Moutai drops as much as 3.3%, the biggest drag on the CSI 300 Index, which declines as much as 1.1%

Wuliangye also loses as much as 3.3%, Jiangsu King’s Luck -6.2%, Shanxi Xinghuacun Fen Wine -3.7%, Anhui Gujing -3.9%

Moutai organized a week-long special training for its sales team, stressing on product price stability, ahead of the Mid-Autumn Festival next month and the National Day holiday in October, according to a Wednesday posting by a WeChat account on liquor industry news

Prices of all Moutai products have dropped marginally in Beijing recently, with its flagship liquor down about 200 yuan to around 2,800 yuan

Capital Securities analyst Gu Xiangjun says liquor shares have had sizable gains recently, adding pullback on Thursday could be “temporary”

Moutai added a total of 7.6% over a three-day rally through Wednesday and Wuliangye rose 5.4% during the period

Kweichou Moutai and Wuliangye are the largest and fourth largest stocks on the CSI 300. That might surprise some people since it is unusual for liquor companies to occupy such large weightings in large economies.

Iron ore’s revival came after it lost about a quarter of its value in the past month, as China’s push to curb steel production hammered demand. But steel and other industrial commodities have rebounded this week, after China’s count of daily Covid cases fell back to zero and central bankers vowed to step up support for the real economy. Coking coal in China hit a record on Tuesday, while copper has also recovered amid signs that Chinese consumers are on a buying spree. 

“Iron ore just cannot be the only one lagging while everything else in steel space is massively bid,” Xiaoyu Zhu, a metals trader at StoneX Financial Inc., said by email. “After the price spike in coal products in the last two days, it’s hard for iron ore to stay quiet.”
 

Steel is as essential to economic development as it has ever been and that makes it a important component of global economic revival. The challenge for China is they have vast oversupply of manufacturing capacity for the alloy and rationalising it is an erstwhile priority.

Huarong’s bailout was reassuring for investors who went through months of agony guessing just how determined the Chinese government was in combating moral hazard. But even with $300 billion in liabilities that could roil banks, suppliers and home buyers, junk-rated Evergrande is seen as a separate case as authorities crack down on excessive leverage in the property sector. 

Investor concerns grew Thursday evening after Chinese regulators demanded Evergrande resolve its debt risks and refrain from spreading untrue information. People’s Bank of China and banking watchdog officials summoned the company’s executives, telling them to maintain operations and protect the stability of financial and property markets, according to a joint statement.  

“The Chinese government’s stance to prioritize social harmony and equality over corporate profit is becoming increasingly clear,” said Anthony Leung, head of fixed income at Metropoly Capital HK. “Evergrande is completely different in the sense that it is the poster child of an industrywide reckless risk-taking culture.”

China Evergrande has been investing in a wide number of non-core businesses for years and will likely be forced to sell all of its appreciated assets in order to avoid bankruptcy. That position as a forced seller leaves it in a weak position to get fair value. Therefore, the only conclusion is the company’s management are been punished for taking on excessive leverage and favoured companies will have the opportunity to pick up renewable energy, batter manufacturing and other positions at a discount.

But the fact that the industry regulator can designate someone to the board of a prominent sector player may unsettle investors worried about the broader ramifications of Beijing’s clampdown. Even before Xi’s administration tightened its grip on the tech sector, ByteDance had grappled with American lawmakers’ accusations that TikTok in particular threatens national security and could aid Beijing in espionage efforts. In May, the month after the Chinese regulator took its stake, founder Zhang Yiming relinquished day-to-day control of his company to its closest lieutenant, a decision regarded as an attempt to distance himself from the growing turbulence at home and abroad.

“It intensifies worries about the government’s intentions for China’s internet sector and the concessions private firms may have to make,” said Michael Norris at consultancy AgencyChina. “It gives new context to Zhang Yiming’s decision to step down from his position as ByteDance’s CEO.”

It seems like the world is finally waking up to overt Communist Party control of Chinese corporations.  This has been going on for years. In 2019 the government placed party disciplinary officials in more than 100 large companies, including both Alibaba and Tencent. At the time that was viewed as an acceleration of the already existing trend. Here is a link to Comment of the Day on September 23rd 2019. 

In the short term, Chinese leaders have an incentive to maintain strict controls at least through next year: They don’t want any major outbreaks derailing the Winter Olympics or clouding a once-in-five-year Party Congress at which President Xi Jinping is expected to get a third term in office. The problem, however, is the rising economic and political costs in maintaining that policy indefinitely, particularly as the virus spawns new variants that can breach restrictions more easily.

“China will have to pivot from its containment strategy, sooner or later -- you can stay Covid Zero for a while, but you can’t stay Covid Zero forever, because the virus swoops in before you know it,” said Chen Zhengming, an epidemiology professor at the University of Oxford. “My worry is that they won’t actively pursue a tactic change as Covid Zero has become an entrenched mentality. Especially when you hold officials accountable, no one dares to go easy on the outbreak.”

Right now it’s nearly taboo in China to even suggest a different approach. In a commentary published over the weekend by a health news app run by the official People’s Daily newspaper, former health minister Gao Qiang called for stronger measures to keep the virus out of China while blasting the U.S.,
U.K. and other countries for easing too early.

“Their sole reliance on vaccination and pursuit of the so-called ‘co-existence with the virus’ have led to a resurgence of the virus,” he wrote. “This is a misstep in Covid decision-making caused by the deficiencies in their political mechanism and the result of upholding individualism.”

China’s spreading lockdowns are already having an economic impact as coastal manufacturing centres deal with a sudden shortage of workers. The longer lockdown orders remain in place the greater the potential the government will need to provide additional monetary assistance.

On November 24th I began a series of reviews of longer-term themes which will be updated on the first Friday of every month going forward. The last was on May 7th. These reviews can be found via the search bar using the term “Secular Themes Review”.

We are 17 months on from the panic low in 2020. At this stage it is quite normal to marvel at the speed of the advance and worry that the pace can’t possibly be sustained. The abiding sentiment is something like “surely, the world is not nearly as good as it was before the pandemic and therefore how on earth can prices be so high?”.

The world is not as good as it was before, millions of people have been deeply inconvenienced and many are traumatized by the events of the last 17 months. The counter argument is the quantity of money in circulation has only been matched during wartime and that has helped to inflate the price of everything. That’s the key to the argument. Having spent so much to achieve this recovery does anyone really believe central banks are going to endanger it? So where do we go from here?

Adding press freedom to the list may benefit those seeking investment too. When a newspaper closes, the local government’s borrowing costs rise because diminished scrutiny makes investors less comfortable, a 2019 report published in the Journal of Financial Economics found. 

Press freedom “is a very foundational thing that needs to be in place before you can have meaningful ESG metrics,” said Perth Tolle, founder of Life + Liberty Indexes, which invests in countries based on third-party rankings of various freedoms. The Freedom 100 Emerging Markets ETF, which tracks Tolle’s index, has no holdings in Turkey or China and also reduced its position in Poland in recent years as concerns have mounted over the country’s erosion of the rule of law. The benchmark MSCI Emerging Markets Index — which Tolle’s index has outperformed this year — has exposure to all three nations. ​

Most investors simply don’t factor in human rights concerns when it comes to allocating capital, Tolle added.

“The metrics are out there, the problem with Wall Street is that they don’t make any money out of those, and they don’t like it,” said Tolle, who was born in China and now lives in Texas. “In places that have no press freedom, do you think they’ll have freedom for stock or bond analysts?

Governance is Everything has been a central theme of this service for decades. It really is as simple as knowing that when you have a grievance, you will have recourse to a system of justice. In order for that to be possible you need property rights and respect for minority shareholder interests. You need an independent judiciary, so your case can get a free hearing. Then you need a free press to help publicise corruption and political overreach so they system can be sustained.

Would be very interested in your thoughts for positioning an investment portfolio (retirement monies) at this point in time. It is increasingly difficult for me to envision what could spark a leg up in the US equity markets in the near term. A leg down at some point feels more probable, yet I am not one for market timing. Nevertheless, increased uncertainty and volatility look to be on the menu for an extended period of time as the markets and Fed wrestle with the curtailing of the liquidity which has fueled the market's run. Is simply pruning equity positions and building cash the most reasonable course of action?

The FullerTreacy service is outstanding and all the more valuable at times like these. Thank you for your thoughts.

Thank you for this question and I am delighted you are enjoying the service. I write a long form summary of my views on the first Friday of every month so I will take this topic up again there.

The big question for investors is how long will the steady rise in the stock market persist? It’s easy to be derailed by valuations and predictions of imminent doom. Instead, let’s focus on consistency and money flows.

China may have questioned the ethics of for-profit tutoring companies in the past. But it did not really act until the enterprises were flooded with speculative venture capital money.

The government saw that as investors hijacking its state-dominant education sector with huge amounts of capital. And so it put a stop to that liquidity train. 

The market-oriented Chicago school of economics acknowledges that a benevolent dictatorship — with the assistance of cumbersome bureaucracy — can be as efficient for social and economic development as a well-ordered competitive marketplace. China — which sees itself as a benevolent authoritarian regime — has tried to maintain efficient capital markets. Now, it’s having second thoughts. In Beijing’s view, hot money is not heading where officials want it to go. Indeed, it was on the point of creating competing power centers that could rival the central government. 

So what can be read from these tea leaves? Stay away from where the hot money is going. Sooner or later, China will curb that enthusiasm and send the sectors into a crash landing. 

The primary aim of an authoritarian regime is to sustain single party rule. Everything else comes after that. China’s administration understands that online forums of any kind represent a point where state control can end. They are also keen to ensure that capital flows only to favoured sectors. Absolute control and the micromanagement it engenders, were some of the primary arguments against the potential success of communist regimes. It remains to be seen how far this trend of increasing authoritarianism will go.

It’s the biggest challenge to China’s strategy since the virus was first detected in Wuhan, the central Chinese city that saw the world’s first lethal outbreak. The country’s strict anti-virus measures, which include mass testing as soon as a case appears, aggressive contact tracing, widespread use of quarantines and targeted lockdowns, have crushed more than 30 previous flareups over the past year.

The arrival of the more infectious delta variant, however, is testing even that approach. The new strain may be exploiting an easing off in masking and social distancing in some places, since much of the country has been Covid-free for months. That, along with increased travel for summer vacation, created an environment where delta could gain a foothold.

China reported 99 infections on Monday, including 44 who tested positive but have no symptoms. Later in the day, seven more people were found to be infected in Wuhan, plus another in Beijing. By number of cases, it’s the biggest outbreak since a flareup in Hebei province in northern China in January, when
2,000 people were infected.

The broad spread is even more concerning, given the rise of cases in the highly protected capital and in Wuhan, whose virus- free status has been a source of pride in China. The seven new cases there are the first since China brought its original wave under control by locking down the city of some 11 million and
the surrounding Hubei province.

China’s stringency in locking down areas where infections are found and testing everyone is likely to keep the current spate of infections from getting out of control. However, the ease with which the Delta variant spreads represents a significant challenge because an increasingly large proportion of the country will need to be locked down. The biggest challenge is the Sinovac vaccine is considerably less effective than MRNA versions, so China will need to double down on its vaccination program before a long-lasting return to normal can be achieved.

The hastily arranged call, which included attendees from several major international banks, was led by China Securities Regulatory Commission Vice Chairman Fang Xinghai, people familiar with the matter said, asking not to be named discussing private information. Some bankers left with the message that the education policies were targeted and not intended to hurt companies in other industries, the people said.

It’s the latest sign that Chinese authorities have become uncomfortable with a selloff that sent the nation’s key stock indexes to the brink of a bear market on Wednesday morning. State-run media have published a series of articles suggesting the rout is overdone, while some analysts have speculated government-linked funds have begun intervening to prop up the market.

The actions taken against the tutoring sector might be well intentioned but to say it is an isolated incident is a step too far. The war on the private sector has been waged for more than a year already. The message is clear. There is now a clear limit on how large companies can grow. We might argue about the merits of this move from a societal perspective, but it makes a nonsense of growth-based valuations. That’s something all investors have to come to terms with.

The first principle of attempting to solve the China riddle is to assume nothing is ever as simple as it seems. Rather than focus on what the government or official statistics say, the only way to interpret the future is to monitor real world actions.

One of our HK analysts wrote this week: “the USA government has issued a joint advisory on the risks of conducting business, studying, and investing in HK, in a direct response to the June 2020 National Security Law (NSL)…which effectively crushed the autonomous region’s special freedoms. Certain multinationals in Hong Kong now face two-way political risk as the U.S.-China decoupling continues…Businesses will be forced to pick a side: adhere to U.S. sanctions and be penalized by China or potentially violate U.S. sanctions to maintain access to Chinese markets. Airlines will need to provide passenger information to authorities before flights depart…to prevent…political dissidents from leaving HK. The NSL allows authorities to conduct wiretaps or electronic surveillance, search and seize electronic devices, requires internet service providers to produce corporate or consumer data. The NSL has dissolved freedom of press in HK. The city’s public radio station is also now under tight censorship...all media based in HK now reflects the political agenda of Beijing. The U.S. has placed sanctions on several individuals and entities within HK, barring U.S. businesses and nationals from transacting with them.”

It is clear that under President-For-Life Xi, the primary condition for portfolio investment in China –the safety of one’s capital in a free system under a Rule of Law- does not, indeed cannot, exist.

This brings us back to the frog. The human tendency to cling onto hope and the status quo can be admirable, but it can also be a pathway to the poorhouse in investment. The destructive forces of late 1930s Germany were foreshadowed a decade before; “Mein Kampf” was published in 1925.

Why not invest in sectors that are actively encouraged by the Chinese state, such as semi-conductors, or which lie outside the ambit of state interference? For institutional investors tied to a global equity index, this is indeed an option, though the tendrils of the Chinese state reach everywhere. For private investors who have no compulsion to invest in China, and who see the world of investment as a “global beauty contest” it may be considered a risk too far. Other more beautiful shores, those that feel the radiation effect of a booming China, may offer more attractive prospects. ASEAN and the free-thinking members of the Trans Pacific Partnership spring to mind.

Sometimes investing is about the return of your money rather than return on it. That’s the challenge for investors in Chinese equities at present. It’s a big question because Chinese stocks represent significant weightings in the broad emerging markets universe. That’s true for both equities and bonds.

What are your thoughts on the Data Security Law to be rolled out in Sept.? Yet another tool the Chinese government is using to control their equity markets?

Thank you for the attached article and this topic question. Here is a section from the Reuters article: 

"They're playing four-way chess here," said Samm Sacks, a cyber policy fellow at think tank New America.

"It's not just a national security policy, it's a much more deliberate plan asking 'how do we really tap into the value that flows from data from an economic standpoint?'"

A digital economy development plan released by the State Council in March lays out a five-part plan for "experimental stage data markets" and calls for authorities to "implement and strengthen the economic supervision" of internet platforms.

The powerhouse province of Guangdong last week announced plans to launch one such platform by year-end to trade and oversee the movement of data, including a customs hub for international transfers.

In the West we tend to think of individual personal and health data as the property of the individual. We share our information with service providers. In return they make products available that we place value in. Platform companies have monetised individual data points to create vast databases of files which are primarily used to sell advertising. China sees the potential but wants to ensure the market grows within arms’ reach of the Party.

“Dear friends,

Many of you outside of South Africa are wondering what is really going on. So here is a very simple outline. The thing is obviously far more complex and nuanced than can be set out in a brief note but this will give you some picture of what is really happening.

Following the 1994 democratic elections in South Africa, South Africa did really well economically until about 2008. That was also the year that Jacob Zuma was elected president of the ANC. At that point in time, some of us had a sense of disquiet already. But little did any of us understand then the extent of the corruption and weakening of government institutions that would follow. We have no clear idea of the extent of what was stolen during the Jacob Zuma years, other than that it is a stupendous sum of money which this country certainly cannot afford. Eventually however the internal tide within the ANC started to slowly turn against Jacob Zuma. On 18 December 2017 Cyril Ramaphosa was elected as the president of the ANC (and also subsequently became the president of South Africa). But it was a very narrow margin of victory.

The thing about Cyril Ramaphosa is that he is fundamentally a principled man. And certainly, determined to clean up the history of corruption we have seen since 2008. Various steps have been taken by him and the ANC under his guidance to give effect to this. One of the things that was done was to establish a commission chaired by Raymond Zondo, who is the Deputy Chief Justice of South Africa. The purpose of this commission was to investigate the corruption issues and to expose them to the light of day.

Jacob Zuma was required to appear in front of the commission. He effectively refused to do so. He was ordered by the Constitutional Court to do so. He defied the order of the Constitutional Court. The Constitutional Court in turn ordered his imprisonment for a period of 15 months for contempt of court. This, whatever you call it, is fundamentally the rule of law in action.

Initially there was resistance to imprisonment by Jacob Zuma and his supporters. A week ago, however Jacob Zuma submitted himself to imprisonment. And then all hell broke loose.

What you need to understand is that Jacob Zuma has his powerbase in KwaZulu Natal, where the riots have been at their worst. This is also, as the name will tell you, the home territory of the Zulu nation. And Jacob Zuma is a prominent figure in the Zulu nation. Within the Jacob Zuma camp, individuals set about instigating the so-called protests, riots and looting that you have seen in the media. To a significant extent they leveraged the problems of poverty and inequality in South Africa to achieve their ends. Very often in this country we have areas where many very poor people are resident adjacent to commercial complexes. This was an ideal combination to exploit. In addition to that there are the existing fissures along race lines that exist in our society which were also available to leverage. Audio files doing the rounds encouraged people to attack and destroy what are perceived to be white and white owned businesses. In the end though, many black businesspeople also suffered considerable losses.

The gameplan was to create a situation which would force the hand of the current government. Ideally, it would result in an overreaction by the security forces, with the result that many of the poor and vulnerable would be killed (which is what happened at Marikana a few years back). If that occurred, it would likely force the resignation or removal of Cyril Ramaphosa as president. Meaning the Jacob Zuma camp would have achieved their objective. This is one reason why the security forces have been so careful not to use excessive force in dealing with the riots and the looters.

While there is still a lot of instability in KwaZulu Natal and certain pockets in Gauteng, what is now starting to emerge quite clearly is that the gambit by the Jacob Zuma camp has failed. South African society of all walks has turned its face against this insurrection. In effect, an attempted coup has failed.

South Africans are a strange nation in many ways. They argue and fight amongst themselves but when pushed to the edge, they always pull together for the common good. This has happened again and again over the decades.

This has been perhaps a necessary test of our democracy and of the rule of law. Make no mistake but that South Africa has many very real challenges. But South Africa will pass through this and will put the locust years behind it.”

South Africa is a country of contrasts but it will survive as long people are willing to pull together during times of crisis. The significant threat to the rule of law that arose last week was a major challenge. The restraint shown by the armed forces, at least so far, is to be welcomed and highlights the fact that there are government institutions capable of acting responsibly and effectively. South Africa’s greatest institutional strength is the independence of the judiciary and a free press. Threats to both these pillars of governance never cease to arise but as long as they survive there is the potential for bounce backs following crises.

The gauge of the city’s tech stocks had fallen as much as 10% this month after China vowed to increase scrutiny over data collection and overseas listings.

“Regulators are still considering each deal case by case and not rejecting all of them. The sentiment is not that negative now,” said Castor Pang, head of research at Core Pacific Yamaichi. “Any good news will trigger buying on dips in the sector.”

Elsewhere, internet giant Meituan rose 3.4% after Caijing reported Monday that the company re-launched a ride-hailing app after industry leader Didi Chuxing was barred from offering new downloads. Short-video streaming platform Kuaishou Technology jumped 5.7% and Alibaba Group Holding Ltd. gained 4%.

Investors want to own Chinese tech shares because they believe they have the growth runway the USA’s tech behemoths had a few years ago. The temptation comes with a price attached because of China’s “rule by law” instead of “rule of law”. The tenor of regulation has the hallmark of being politically motivated but the trade is the Party may not be quite willing to kill the sector.

It’s inevitable to see selling from investors who had been pinning their hopes on Didi,” said Tomoichiro Kubota, a senior market analyst at Matsui Securities Co. in Tokyo. “If it’s deleted from app stores, it’ll be a very difficult situation.”

China’s cyberspace regulator announced the Didi ban on Sunday, just two days after revealing a review of the company. The decision effectively requires the largest app stores in China to strike Didi from their offerings, though the current half-billion existing users can continue to order up rides and other services. Didi said the regulatory move may have “an adverse impact” on its revenue in China.

On Monday, regulators expanded the probes further to target Full Truck Alliance, which runs an Uber-like platform for truck-hailing, as well as Kanzhun Ltd. Full Truck Alliance, backed by Tencent Holdings Ltd. as well as SoftBank, raised $1.6 billion in its U.S. offering last month.

The Vision Fund was bloodied by the failure of WeWork. Since then, Softbank has since been eager to accelerate the pace of IPOs for the companies it invested in. Didi is a big one and there was no way they could risk missing out on a pay day.

Two weeks ago, the Chinese regulator warned Didi not to pursue its IPO. It appears large investors like Softbank and Uber pressured the company to file over the Communist Party centenary celebration to take advantage of a lull in regulatory enforcement. In doing so the company raised $4.4 billion in cash, achieved a valuation in excess of $70 billion and was promptly banned from Chinese app stores.

On November 24th I began a series of reviews of longer-term themes which will be updated on the first Friday of every month going forward. The last was on May 7th. These reviews can be found via the search bar using the term “secular themes review”.

News today that Johnson & Johnson’s vaccine is effective against the delta variant should help to allay fears that the world is about to experience a round of upheaval similar to early 2020.

There is no question that the pandemic has acted as an accelerant. It forced migration and adaption to new conditions in a manner that might otherwise never have happened. Some of those changes will stick, others will fade away.

Everyone seems to think that the pandemic has to mean something and that we will never again get back to normal life. I don’t believe it. The surges back into social activity whenever restrictions are lifted is confirmation that humans are social beings. We crave physical contact and fellow feeling. That’s not going to change, even if we have a better appreciation for it today than since the demise of organised religion.  

As with every other crisis, the liquidity created to deal with the shock will remain in the system for much longer than it is strictly required. Central banks cannot afford to jeopardise the recovery they worked so hard to create. Meanwhile, populations everywhere are impatient for better conditions.

“Xi used the speech to show that the CCP has wide support from the public and enjoys high-level popularity among Chinese people, which in turn shows that he himself has the support and popularity,” said Deng Yuwen, a former editor at the party’s Study Times journal. “Xi has also used the speech to send a stern warning to the U.S. and the West, and that’s when the audience responded most enthusiastically.”

100 years since the founding of the Communist Party is a momentous anniversary. It is a time for reflection and to think both about the lessons learned and the ambitions for the future. The primary importance of the century anniversary is the people who struggled to achieve victory at the dawn of the epoch are long dead. Those entrusted with responsibility today rest on the laurels of people they have little in common with because cultural memory of struggle is not the same thing as experiencing it in person.

"The current situation on the border between China and India is generally stable, and the two sides are negotiating to resolve relevant border issues," Chinese Foreign Ministry spokesman Wang Wenbin told a regular press briefing in Beijing Monday in response to a question about troop deployment. "In this context, the words, deeds and military deployments of relevant military and political leaders should help ease the situation and increase mutual trust between the two sides, not the other way around."

The fear now is that a miscalculation could lead to an even deadlier conflict. Several recent rounds of military-diplomatic talks with China have made minimal progress toward a return to the quiet status quo that had prevailed along the border for decades.

“Having so many soldiers on either side is risky when border management protocols have broken down,” said D. S. Hooda, a lieutenant general and former Northern Army commander in India. “Both sides are likely to patrol the disputed border aggressively. A small local incident could spiral out of control with unintended consequences.”

The northern region of Ladakh — where India and China clashed several times last year — has seen the largest increase in troop levels, three of the people said, with an estimated 20,000 soldiers including those once engaged in anti-terrorism operations against Pakistan now deployed in the area. The reorientation means India at all times will have more troops acclimatized to fight in the high-altitude Himalayans, while the number of troops solely earmarked for the western border with Pakistan will be reduced.

India is a front-line country and NATO+ hope it will act as a counterweight to China in the region. That means it is likely to be afforded a helping hand in the form of aid, regulatory laxity and technology transfers to ensure it is capable of resisting Chinese adventurism.

Some officials “may see the foreign-exchange liquidity as a feather in China’s cap, and some may worry that the surge is flighty,” said George Magnus, a research associate at Oxford University’s China Centre. “It’s fine when the flows are coming in, but a big problem for financial stability when they try and go the other way.”

For Magnus, the increase in dollar deposits is “random and most likely temporary,” and will slow when other nations recover from the pandemic.

While it lasts though, the situation offers an opportunity for China to implement reforms and loosen its grip over its tightly controlled capital borders.

“China will take the chance of flush dollar liquidity to make its cross-border flows more balanced,” said Becky Liu, head of China macro strategy at Standard Chartered Plc in Hong Kong. “Policy makers in the coming two to three years will keep widening channels for funds to leave the country.”

China’s accumulation of Dollars as a result of the relative strength of the economy during the pandemic should naturally put upward pressure on the currency. The rally over the last year is at least a partial reflection of that. The big question is how do they loosen capital controls while also discouraging capital flight?

It may come as a surprise to learn that Tel Aviv (Israel), Vilnius (Lithuania), and Tallinn (Estonia) all rank in the top 50 cities in the world in Fintech. You may not yet have heard of many of their leading companies, but I’ll wager you will in the coming decade. Lithuania ranks number one in the world in terms of broadband speed and in the top five countries for Fintech innovation. Investment in the right infrastructure has given that country a head start it is not wasting.

Access to capital and need for less of it in today’s capital-lite, ‘free money’ world means more and more entrepreneurs, the geniuses who will lead the exceptional companies of tomorrow, no longer feel anchored to the US. 20 years ago, fewer than 15 per cent of Chinese students studying abroad felt compelled to return home, filled with ideas but lacking the capital to fund their ambitions. Today closer to 80 per cent see a much more favourable environment in which to put their western education to profitable use domestically.

Adding to the earlier comments on the popularity of the Hong Kong stock market, companies are increasingly eschewing an ADR listing entirely, preferring a Hong Kong local listing, with exchange regulators encouragingly supportive. For the Chinese company of the future, a dual listing may well mean H-shares (HK) and A-shares (mainland China).

In a world obsessed with buybacks (at the wrong time) and cost-cutting (at the wrong time), we look for investment and expansion. Here, the US is no longer the world leader it once was.

There is an exceptional amount of competition for attention in today’s market. The wall of money printed in the last year has refocused attention on relative performance of assets. Interest rates and currency movements play a big part in how well international assets fare versus US assets. That’s particularly relevant for large pools of US capital that have mostly stayed at home over the last decade.

Is China Evergrande an isolated problem or should we be concerned that this is a common problem throughout the Chinese economy (and thus much more to be concerned about)?

Thank you for this relevant question and this link to Grant’s free newsletter. Here is a section:

The unfolding Evergrande saga is taking a toll on the Chinese offshore bond market, as yields on the ICE BofA Asian Dollar High Yield Corporate China Index rose to 9.93% on Friday, up from 8.5% as recently as May 26 and far above the 4.65% on offer for the equivalent U.S. gauge. That 536 basis point spread marks a near-decade high, apart from a brief spasm during the March 2020 liquidation. Yet, that rough price action hasnʼt derailed insatiable investor appetite for yield: Chinese developers sold $20.3 billion in dollar bonds through June 2 per Refinitiv, up 16% from last yearʼs pace and running “completely contrary” to investor expectations for subsiding deal flow, Owen Gallimore, head of credit-trading strategy at ANZ, commented to The Wall Street Journal.

More broadly, as a debt-fueled fixed asset investment and a bloated financial system (featuring $50.3 trillion in banking assets as of March 31, more than half the $84.5 trillion in global GDP last year) stand as the centerpieces of the Chinese economic miracle, a brisk pace of economic growth is paramount for avoiding trouble.

Yet on that score, recent data are less than encouraging, as total social financing (i.e., aggregate credit and liquidity flows) came to RMB 1.92 trillion in May, light of the RMB 2 trillion consensus estimate to mark the third straight negative surprise. Similarly, M2 money supply growth registered at 8.3% year-over-year in May, down from 10.1% three months earlier and near the lowest level since at least 1996, while the credit impulse (or growth in borrowing as a percentage of GDP) slipped to 25.6% last month, down from 31% in February and the lowest reading since early 2020.

Quid pro quo is a dangerous mix when it comes to debt markets because one of the easiest ways to raise funds is to boost leverage through convenient relationships. If I need more funds, it is easy for me to buy a portion of your bank in return for your boosting leverage to invest in my company. The challenge is this is a simple transaction but the underlying web of interconnectedness across the developer/bank/materials/local and national government level is probably impossible to clearly identify.

In China, technology adoption promises its swelling middle classes an easier, more productive life. But as companies bring productivity-enhancing tools into everyday office life, their efficiency is being channeled, not into leisure time, but into squeezing ever more value from employees.

Just as algorithms have come to govern the workdays of blue-collar warehouse workers at Alibaba Group Holding and food delivery riders for Meituan, elsewhere, white-collar workers are becoming affected by the creep of software-driven management and monitoring into their professional lives.

This is particularly the case in China's tech industry, where rapid technological development, paired with poor labor regulations, has created a potential for labor abuse. The big tech companies themselves, locked in cutthroat competition for new business opportunities, are pioneering these technologies and tools in their own operations. From hiring and goal-setting to appraisal and layoff, productivity-enhancing technologies look to quantify workers' behavior by collecting and analyzing extensive amounts of personal data.

Some scholars warn that some practices can be unethical, invading employees' privacy and burdening them with greater workload and mental stress. Others draw parallels to the fatigue faced by factory laborers during industrial revolutions, where workers chased the pace of machines.

"I felt that I was getting busier and having less time for myself," said the engineer Wang, looking back on his five years at Chinese internet companies.

Asian work culture is not something many in the West are familiar with. Long hours, arriving before the boss and leaving after him are normal work practices. Not taking holiday, an expectation to do whatever is asked and the assumption of absolute loyalty are common characteristics of working in Japan, China, South Korea and elsewhere. When a Japanese newspaper talks about potentially overworking individuals it is worth paying attention. Afterall Japan has a word for being worked to death. (karoshi - death by overwork).

The task of coordinating that sprawling program now falls to Liu, who has to keep track of the relevant resources and drive the national strategy to help China achieve chip independence.

“For our country, technology and innovation is not just a matter of growth,” Liu told a three-story auditorium packed with China’s top scientists in a separate meeting in May. “It’s also a matter of survival.”

Xi is counting on his lieutenant to help China fend off growing threats from the U.S., which is seeking to take back chip industry supremacy. Under the Trump administration, sanctions were slapped on Chinese giants from Huawei to SMIC, cutting off their access to American technology and equipment crucial to designing and making advanced logic chips. President Joe Biden has also laid out a $52 billion plan to bolster domestic chip manufacturing, while calling on allies to join export controls aimed at curbing Beijing’s drive toward technology self-sufficiency.

Rival powerhouse nations like South Korea and leading corporations such as Taiwan Semiconductor Manufacturing Co. have also responded with their own spending plans, fueling the race to take the lead in the sector.

With traditional chipmaking facing a series of challenges from technology development to heavy capital investment, third-generation chips -- which use compounds such as gallium nitride and silicon carbide to significantly improve the performance of semiconductors that power a wide range of industries and products -- may offer China its best chance to overcome rivals, senior academic Mao Junfa told an industry event in Nanjing earlier this month.

“China couldn’t buy chips, even with cash in hand,” he said, referring to Washington’s sanctions on Chinese tech companies including Huawei. “The compound chip technologies could help China surpass rivals in the post-Moore’s Law era.”

A decade ago, China needed a domestic demand led recovery so social media, ecommerce and mass consumerism were promoted. That allowed Alibaba, Tencent etc to become some of the largest companies in the world. Their economic function has been realised and now efforts are underway to curtail their growth, lest they become a challenge to the political status quo. The opening of an antitrust investigation of Didi ahead of its IPO is one more example of how the growth of the most successful companies is being curtailed. 

Thanks to e-commerce, the world has gotten used to buying all sorts of daily necessities online. Automakers in China will soon be afforded the same convenience, with the ability to purchase must-have autonomous driving data from a central repository.

For that, credit must go the China Association of Automobile Manufacturers, which has been working on a Vehicle Data Platform with industry players for the past three years. Its launch is expected any day.
China, a pioneer in the promotion of electric cars, is exploring a credible and efficient way of storing, sharing and utilizing data to help automakers speed up their efforts in making autonomous driving a reality. In the intelligent and connected car space, data is as important to vehicles as crude oil is to internal combustion engine cars.

The issue is scale. Thousands upon thousands of terabytes of sensory data must be collected, analyzed and interpreted to produce the technology that ultimately allows cars to navigate roads, highways and obstacles themselves.

Currently, this valuable information is in the hands of individual companies, which are trying their best to use it to “train” the brains of intelligent vehicles as humankind races to that point where we can take our hands off the steering wheel altogether.

Tesla was welcomed into China with open arms. The company’s factory outside Shanghai was built in record time and every effort was made to remove regulatory roadblocks to begin production. Sales naturally followed and the move looked like a success. Then there was an accident and a loud public (orchestrated) outcry, with protestors standing on cars at a media junket. Now, a reservoir of self-driving data is being created and all companies active in the space will be expected to contribute what they have.

While European broadcasters are still profitable, “and some very much so,” Godard highlighted, “savvy investors believe this is looking suspiciously like the high earnings of printed newspapers circa 2007, or a Wile E. Coyote run over the edge of the cliff. Broadcasters are capturing a declining share of total video audiences and their capacity to finance attractive content is shrinking as talent is bid up by SVOD operators.”

The analyst then outlined two consolidation options that have emerged in Europe.

“The first path — heralded by Bertelsmann RTL Group — would aim at creating national broadcasters with the content scale to operate compelling online platforms” via domestic acquisitions, Godard said, calling this the “possibly more defensive but also more realistic” option.

The second path is “more ambitious but lacking a credible backer,” he argued. It targets “the never achieved idea of pan-European synergies, leveraging increased international appetite for non-English language content” by merging assets across borders, something that the likes of Italy’s Mediaset and Vivendi have talked about. “But its champion, Italy’s Mediaset, lacks capacity to deliver,” Godard concluded.

“The group is already the biggest broadcaster in Italy and Spain and has built a 24 percent stake in Germany’s ProSieben, with the remaining shareholding fragmented,” he explained. “The problem is, if the cross-border strategy is sound, Mediaset may be its worst possible proponent. Besides bringing in strong leadership to its Spanish division, Mediaset never extracted significant synergies from its two Mediterranean units, despite their cultural affinity.”

National broadcasters survive because they have state backing and a captive audience. The value proposition they represent is tied to continued support from governments because they provide domestic language content. That does not transfer well internationally. This map of the 12 most spoken languages in the world suggest the biggest opportunities are in the Chinese, English, Spanish, Hindu-Urdu and Arabic speaking parts of the world. 

On November 24th I began a series of reviews of longer-term themes which will be updated on the first Friday of every month going forward. The last was on May 7th. These reviews can be found via the search bar using the term “Secular Themes Review”.

The pandemic panic is now one year in the rear-view mirror. It seems to have lost its ability to scare us so that begs the question what happens next? That’s the big conundrum

Some still believe that technology will solve all our problems and that the largest companies in the world will continue get even larger. Others believe that the inflation genie has been releases so it is inevitable that bonds will collapse in value. Others believe that we are in for a long grind of subpar growth because the debt is so large, it will sap the will to live out of every speculative asset. Others believe we are in a stock, commodity and property market bubble that could pop at any moment. Still other believe that cryptocurrencies are the solution, though no one is exactly sure what the problem is. So how do we make sense of these divergent views?

Personally, I have a strong feeling of déjà vu. In late 1999 and early 2000 I was selling Optus cable connections door to door in Melbourne. When I tired of backpacking, I went to London and within three weeks had started at Bloomberg. I was amazed at the speed of the Royal Mail. I saw an ad in The Times on a Wednesday for European sales people. I posted my CV that afternoon and had a reply back from Bloomberg delivered the next day. I had an interview on Monday and started on Tuesday. To say they were desperate for sales people is a gross understatement. I was in Belgium, visiting private banks, 10 days later. That was the top of the market and it was evidence of a true mania in the TMT (Telecoms, Media and Technology) sectors.

By the end of the Nasdaq bear market in 2003 the number of Bloomberg terminals being sold to mortgage bankers was surging. I was even offered a job by one. The Dollar was pulling back, there were fears about financial repression, China’s demand for commodities was only beginning, emerging markets were breaking out and gold was completing its base formation. A year later oil broke out.

Beijing’s efforts to talk down commodity prices and impose more control over financial markets have sent investors into more defensive assets such as consumer stocks with steady cash flows. Liquor giant Kweichow Moutai Co., mainland’s biggest stock, rose 6% after Chinese media outlets reported its parent company aimed to double revenue by 2025.

“Beijing’s crackdown on commodity prices has forced more funds to seek shelter,” said Zhang Gang, a Central China Securities strategist. “Stocks such as Moutai are attractive given its stable earnings outlook and relatively reasonable valuation following this year’s correction.”

Two pieces of news on China hit the headlines today. The first is that Goldman Sachs and ICBC have formed a joint venture for wealth management clients. The second is the central bank is at least comfortable with the current strength of the Renminbi and may be inclined to allow it to appreciate further. Both are positive for asset prices.

Weber: What puzzles me about the idea that the problem lies in Chinese “state capitalism” or China’s active state participation in the market is that this is not unique to China. Other states also have historically had quite extensive industrial policy and state engagement. It seems that the tensions between China and the West have been mounting since China moved from being the workshop for companies headquartered in the West toward trying to establish its own companies that can reach the technological frontier. That of course required the state, as China was starting from a position of relative technological under-development.

Browne: Local experimentation accounts for much of China’s early economic success. But these days, the approach is more top-down. Is that a problem?

Weber: First of all, I think we have to recognize that the 1980s is really this moment of great openness before a new paradigm has settled. This is a little bit like what we might be observing right now in the U.S. context, where suddenly all of the premises that we used to have in economics, especially in economic policymaking, seem to be up for debate. Obviously, this moment of openness cannot last forever. Eventually the mist settles, and you get a new, more consolidated system.

China is a country populated by large numbers of industrious, inventive people who are ruled by an autocratic regime that is terrified of the peasant revolts that have toppled many previous dynasties. The only way for them to ensure control is maintained is clamp down on any form of protest while simultaneously attempting to sustain productivity growth. It’s a tall order and will require continued political evolution if they are to succeed.

On November 24th I began a series of reviews of longer-term themes which will be updated on the first Friday of every month going forward. The last was on March 5th. These reviews can be found via the search bar using the term “Secular Themes Review”.

After a crash everyone is wary. We all seek to learn lessons from our most recent experience because it is the only way to help us emotionally move past the trauma. Coming out of the pandemic most investors wished they had sold everything at the first sight of virus news in early 2020 and bought everything back again following the crash. Today they are worried that there is another big shock waiting around the corner that will cause a repeat of pandemic panic.

The challenge for investors is less to learn from the most recent mistake but rather to know when to deploy the lessons learned. The best time to be wary about a massive decline is when no one is worried about it. The time to take precautionary action is when it seems like a waste of time and when you are most afraid of giving up on the potential for even better gains. That’s the best time to remember the experience of the crash but the interval of time and the positive reinforcement of experience in an uptrend make it difficult.

Before the pandemic, economic growth was decelerating as confirmed by a decline in world trade in 2019, one of the few yearly declines in the history of this series. While the huge debt financed programs were a response to the pandemic, the end result is that global nonfinancial debt increased to a record 282% of GDP in 2020. The 37% surge of debt relative to GDP was also a record. While this debt may be politically popular and socially necessary, it will weaken growth and inflation after a transitory spurt, which will lead to even more disappointing business conditions than existed prior to the pandemic.

The actual global debt situation may be worse than these numbers indicate because they include China, the world’s second largest economy. Scholarly forensic research indicates that Chinese GDP is overstated by at least 18%. Thus, the official Chinese debt to GDP ratio is suppressing the global numbers. A comparative analysis of money velocity confirms the suspicion about the Chinese figures. Money velocity in China in 2020 was 0.44 versus 1.19 in the U.S. Admittedly money and debt are not identical, but they are opposite sides of the balance sheet and the glaring gap is too much to be ignored.

A link to the full report is posted in the Subscriber's Area.

Something that has been troubling me for a while is why has China chosen now as the time to clamp down on Alibaba and Ant Financial’s massive money market fund. The rationale that it was politically motivated and that the firm has become too big and powerful for the comfort of the Communist Party is tempting and probably holds some truth. However, the bigger question is whether the financial system needs to reabsorb the flows and be refortified because the debt overhang is much larger than investors are willing to give credence to?

The Australian federal government scrapped both the memorandum of understanding and framework agreement signed between Victoria and China’s National Development and Reform Commission, Beijing’s top economic planning body, Foreign Minister Marise Payne said in an emailed statement Wednesday. She described the deals as “inconsistent with Australia’s foreign policy or adverse to our foreign relations.”

The step “is another unreasonable and provocative move taken by the Australian side against China,” the Chinese embassy in Canberra said in an emailed statement. “It further shows that the Australian government has no sincerity in improving China-Australia relations -- it is bound to bring further damage to bilateral relations, and will only end up hurting itself.”

Australia “basically fired the first major shot against China in trade and investment” conflicts, Chen Hong, director of the Australian Studies Center at East China Normal University in Shanghai, told the Communist Party-backed Global Times. “China will surely respond accordingly.”

China has lodged stern representations with Australia over the issue and reserved the right to take more action, Foreign Ministry spokesman Wang Wenbin said at a regular press briefing Thursday in Beijing.

China may successfully be able to cow smaller countries into submission by following a carrot and stick approach to infrastructure and trade development. Australia is a different story.

The big question now confronting investors is how much pain China’s government is willing to tolerate as it tries to wean the bond market off implicit guarantees. None of the state-owned companies that have defaulted so far -- including Peking University Founder Group Corp., which is ultimately controlled by China’s education ministry -- were considered as systemically important as China Huarong.

Chinese authorities have tried to strike a balance between instilling more market discipline and avoiding a sudden loss of confidence that might spiral into a crisis. But the tumult surrounding China Huarong, some of whose bonds are now trading below 80 cents on the dollar, highlights how quickly investor sentiment can deteriorate even at a time when the economy is strengthening.

“China’s credit market is entering a new era as SOEs are emerging as the main source of stress,” said Shuncheng Zhang, an analyst at Fitch Ratings. Whatever the outcome for China Huarong, policy makers will likely allow more defaults in the state sector to reduce moral hazard and cultivate a more mature debt market, he added.

Huarong was created as a bad bank, where the defunct loans of China’s banks were dumped 20 years ago. The generally accepted business model for these kinds of entities is they end up with hard to value assets and are given the time required to sell them at profitable rates. That’s how Ireland’s bad bank functioned in the aftermath of the Global Financial Crisis for example. The fact that Huarong is now running into trouble is reflective of the fact that it long ago departed from its bad bank foundation to imitate the business model of the banks it was designed to clean up.