Market Thinking

making sense of the narrative

The Mountains are high….

There is a tendency in the west to see China as an authoritarian monolith – in contrast to the supposedly highly accountable democratic west, albeit only those with the shortest of memories can look at the current protests against Covid taking place in China and think them somehow unique*. The reality is, of course, different, for while over the course of his first two terms Xi has certainly moved to consolidate more power to the centre, the fact is still that, in the words of the old Chinese proverb, “The mountains are high and the Emperor is far away”, ie the relative autonomy of the regions remains strong and thus the Covid restrictions – and by extension the protests – reflect a tapestry of different regional interpretations of central government policies. Right now, it seems that the centre is asking the regions to ease back on Covid restrictions, which is why, despite the headlines, the markets believe this is more about opening up than closing down again. 

A more useful way to think of China is as being like Europe and the EU; a set of regional economies with a high degree of autonomy but with a centralised controlling permanent bureaucracy that nevertheless has its own internal politics and factions. Geographically, it is also about the same size as Europe and the variation in climate as well as language/dialect puts Harbin in the north at the equivalent of Norway while Hong Kong is down at Gibraltar. 

It helps to think of China as being like the EU

China has 23 Provinces, 5 Autonomous regions and 2 SARs (Special Administrative Regions) in Hong Kong and Macau. In comparison, the EU is 27 countries, with 3 in the EEA and two that are effectively SARs (in that they have separate legal administrative and judicial systems) in UK and Switzerland.

*Memo to China; Covid protests are so last year…

Thus, as the montage below shows, while the official Covid response was co-ordinated at the EU level, (amidst a lot of ongoing controversy), dealing with widespread anti Lockdown protests in 2020/21 was done at the ‘local level’. As such huge rallies in UK, Germany, France, Italy, Poland (just to mention the ones pictured) were met with local response including enormous amounts of police and not a little violence – albeit with rather less coverage than is currently being given to China. (Note the montage also includes Australia, which had some of the most draconian lockdown policies – even if the press, currently talking about China, seem to have forgotten.) The central government in China is thus currently in a similar position of trying to get the regional governments to manage the protests better and the markets are betting they are going to win.

All this is to say that, as always, we need to be careful what narrative we are following and in whose interest it is for us to believe it. Obviously, the US clearly sees China as its new great rival, and thus the dominant US driven western narrative is going to be negative from now on, but, as investors, we need to make our own assessment and watch what China is doing rather than rely on the predictions of others. In this context, it is worth remembering that China has a tendency to ‘test’ new policies on certain regions before going ‘nationwide’ with them. Thus, it is entirely possible for, say, the Greater Bay Area, including Hong Kong, to see an earlier easing of Covid restrictions than other parts of the country. Indeed, watching the recent spike in the prices of Macau casino stocks, the locals are clearly looking at things this way.

China has a tendency to ‘test’ policies regionally, before going nationwide. As such places like the Greater Bay area could open up more quickly

This is also important in the context of, yet another, US hedge fund driven discussion about the likelihood of the Hong Kong peg breaking, a trade likely to prove as fruitless as the last few attempts have been. While China is undoubtedly moving away from using the $ for anything other than direct trade with the US, the most likely direction of travel would be to simply peg the HK$ against a trade weighted basket, similar to the informal approach used currently to manage the Rmb itself. This would enable the Chinese currency itself to remain only semi-convertible, while allowing Hong Kong to resume its previous role as ‘the interconnector between the rest of the economy and the rest of the world’. Of course, the wider use of Central Bank Digital Currencies will facilitate both this and the ability to limit capital flight., making de-dollarization of the BRICs and Shanghai Co-operation Council (SCO) countries a major theme that is emerging.

The steady re-opening of China is thus, in our view, one of the main themes for 2023 and while many are understandably concerned at some of the images coming out of China, we believe that the direction from the central government is for less rather than more lockdown. Perhaps ironically, investors concerned over inflation should probably be thankful that the central government delayed re-opening as long as it did, for if China had re-emerged as quickly as the west did and at the same time, into a world of shattered supply chains and inventory bottlenecks, then the impact on commodity prices would have been dramatically worse. As it is, the steady opening up next year is still likely to be a positive tailwind for industrial metals and other commodities. 

This is an extended version of an article submitted to Livewire.

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