As Xi Jinping heads to the United States he might need to check that he takes his irony meter with him, for there seems little evidence that anyone in the Western media has one they might be willing to lend him. Wall Street titans are lining up to criticise China for apparently interfering in financial markets, despite having spent much of the last 7 years demanding that the Federal Reserve do exactly the same thing. CEOs and pension fund managers talk darkly of the need for reform of state owned enterprises while happily funding or ignoring vast lobbying operations in Washington and Brussels that exist to ensure that the vested interests of Western crony capitalism are protected. Meanwhile economists bemoan a lack of growth in an economy that is larger in terms of GDP than France, Germany and the UK combined and continues to provide one quarter of all global growth. If any one of these European countries was growing at 4% or 5%, let alone 6-7% the same economists would be demanding higher interest rates and panicking about inflation. Anecdote based policy prescriptions abound, as does talk of bubbles and policy mistakes as if the last 7 years in Europe and the US had been plain sailing!
President Xi will of course recognize the vested interest in much of this commentary, but he might also be puzzled by a lack of awareness in the West, not only of the aims and needs of China but also a lack of self-awareness at the position the West has got itself into. I make no claims to being a China scholar, but as an investor based in Hong Kong it is clear to me that the further you get from China, the more certain people are that they know what is going on and the more black or white their views are. They are either hugely optimistic or hugely pessimistic, as most are now. The closer you get to China, the more complicated it is, and the more opportunity there is for investors, should you care to look. For example, while undoubtedly this visit will see lobby groups call for China to reduce its CO2 emissions, investors need to recognize that the priority for China is reducing particulate pollution. This means more nuclear, more solar more trains and more initiatives on electric vehicles, rather than western favorites such as carbon capture and storage and carbon credits. Equally talk of bad debts and property bubbles miss the fact that China, like the US or Europe is a continental economy so there are always winners and losers. Talk of ‘ghost cities’ in Mongolia as a reason to worry about all Chinese property makes no more sense than saying property prices in Greece, or Portugal or Detroit are reasons not to invest in London Paris or New York.
Over the last 20 years, China made a lot of non-Chinese countries, companies and investors very rich, especially in the commodity space, but we need to recognize that this was a bug, not a feature. We are now dealing with China Growth 2.0 and the international winners will be different, and fewer. Understanding what China is trying to achieve will be crucial to being one of those winners.
A classic example of the West viewing China through its own prism has been the reaction to the recent depreciation of the currency. By the standards of the 20% drop in the euro Swiss exchange rate earlier in the year, a 3% move as China allowed for a wider band and a closer link to the market-set exchange rate was hardly seismic, but to Western traders who had large leveraged bets based on flawed volatility based measures of risk it was a shock. It is thus presented that China should not have surprised markets, but in reality, the traders have to ask themselves why the Chinese should think about their welfare? They did not ask them to speculate, indeed as with most policy (and in direct contrast to the popular perception) the actions of the Chinese authorities suggest they are doing everything they can to deter speculation rather than encourage it. Other Western commentators have declared this to be the start of currency wars and claim that China is trying to boost its exports through a weaker currency, but as far as I can see everything to do with the currency is actually about the capital account, not the current account.
A key aim of the visit will be to secure US approval for the Chinese currency to enter the SDR basket of the IMF, something regarded as key to the opening up of the Chinese capital account. For this the yuan has to float freely against the US dollar, otherwise it is just a clone, so it needs to be volatile, but not too volatile. In a similar manner it seems to me that the Chinese want the currency strong, but not too strong. If it appreciates too much, and the irony meter here is useful when US politicians threaten to cite China as a currency manipulator when the RMB has appreciated by 20% over the last 5 years, then Chinese companies tend to borrow dollars to invest onshore, creating a bubble which is not desirable and we also know that foreign currency debt is rarely a good thing. Equally an important reason not to have too weak a currency is that China is very keen to attract long term Western investment capital and this is because it needs the West to help it develop a 21st century financial infrastructure.
This is key. China is the second largest economy in the world, but it still has a very immature financial sector and for much of its recent growth phase it relied on Western financial infrastructure. Post the 2008 crisis however; China recognized the need to develop a proper financial sector of its own alongside its other economic reforms. The last 2 years in particular have seen a blizzard of announcements on initiatives to liberalize the financial sector. Initiatives such as mutual recognition of investment funds, the investment quota systems and the Stock Connect investment schemes have all been picked up on by certain parts of the Western financial community, but almost totally ignored by the mainstream. Behind all this is a steady opening up of the capital account and the building out of a developed economy financial infrastructure, which is throwing up all sorts of opportunity. For example, the local government debt we are supposed to be worried about is in many cases backed by extremely sound assets such as toll roads, airports, business districts and shopping malls and we have been told this will be repackaged as much needed asset back securities. The Western financial sector can and should participate in this.
Equally the Asian Infrastructure Investment Bank, that the US tried so hard to prevent, is less about undermining the World Bank and more about recycling Chinese reserves into greater Asia via the ‘One Belt, One Road’ infrastructure projects. More trade and increased productivity will boost growth generally far more than any derivative of QE as demanded by Wall Street and while it will undoubtedly favor Chinese companies, many of whom have issues of excess capacity; the West can certainly invest alongside. Infrastructure bonds thus look set to be a major new growth area. There is much more. Should the US care to look, it will see many parallels with its own growth path during the 20th century and just as the UK and Europe learned to deal with the changing growth patterns of the US back then, so they need to adopt to the next phase for China.
The opinions expressed here are the views of the author and do not constitute investment advice. They do not necessarily represent the views of any company within the AXA Investment Managers Group and may be subject to change without notice. No financial decisions should be made on the basis of the information provided.
