Why China is uninvestable

Last month, China engaged in its largest injection of monetary stimulus since the COVID-19 pandemic.  The government also indicated that fiscal stimulus is on its way. All-powerful Chinese Communist Party Chairman Xi Jinping wants to revive China’s moribund economy. China says its economy is growing at a rate in excess of 5%, but that does not seem plausible in the context of weak manufacturing data, slow household consumption, and a banking system that is broken. 

Stimulus measures are unlikely to reignite the Chinese economy. The government is not addressing its fundamental economic problems: diverting capital from the more productive private sector to the capital-destroying state sector, a focus on national security over economic growth, recapitalizing its banking system, a residential housing market that is in deep depression, and a household sector that is unwilling to spend because there is no national safety net for health or pensions. The Chinese stock market has flatlined over the last 15 years. By contrast, the U.S. S&P 500 is up almost 300% over the comparable period.

It’s not surprising that Chinese investors and American hedge funds piled into the Chinese equity market on the announcement of government stimulus. Noted American hedge fund manager David Tepper sparked the American exodus into China when he said on CNBC, “Buy everything.” Tepper is the leader of a pack. American hedge fund sheep followed him. But if anything, theirs is a short-term trade. To use financial market vernacular, it is a dead cat bounce.  

The Chinese economy must undergo fundamental structural reform. But Xi prefers political stability to a vibrant economy. China faces many challenges that Xi is unable or unwilling to tackle. In most modern economies, household consumption accounts for 60% of GDP. In China, personal consumption only accounts for 40% of GDP. Again, Chinese households have a very high personal savings rate because there is no Social Security system to support them. In addition, because of China’s catastrophic one-child policy, the elderly know they cannot rely on their children. The people of China must save, or they will die in poverty. 

China has invested those excess savings principally in real estate. But China’s real estate companies are going bankrupt. There aren’t enough people to live in the new apartment blocks. China has far, far too many empty city blocks. In turn, China is trying to export its way out of its growth dilemma. But China’s trading partners are pushing back with import tariffs. Both the United States and the countries of Western Europe refuse to be the dumping ground for excess Chinese production.

Making matters worse for Xi, China is in a demographic and employment doom loop. The Chinese population is declining. Chinese workers are experiencing wage deflation. Dynamism can’t fix this problem because all-knowing Xi simultaneously discourages entrepreneurism by arresting or silencing his most innovative business people. This means that no one in China wants to be known as the wealthiest person in the country. The wealthy fear the knock on the door at midnight. Chinese millionaires are fleeing the country in droves.

The lack of opportunity in the Chinese economy is illustrated by its very high youth unemployment rate, approaching 19%. When young people can’t find jobs, the future is dark.

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Top line: Xi has a big problem when China’s best and brightest are fleeing and Americans are piling in to make a fat buck.

It is never a good idea to invest in communism.

James Rogan is a former U.S. foreign service officer who later worked in finance and law for 30 years. He writes a daily note on the markets, politics, and society. He can be reached at [email protected]