Much as Chinese regulators and Citigroup might prefer to sweep the past week’s events under the rug, there is no avoiding the sense that a Rubicon has been crossed in China’s relations with foreign investors. Months from now, analysts will likely look back and circle an inflection point on their charts while academics will be engaged in endless debates over how far Chinese policy on the use of capital has shifted. It might take a bit longer for historians, but they will surely soon start drafting treatises about the moment Xi Jinping redefined Socialism With Chinese Characteristics.
Neither the Party leadership nor the foreign investment community are likely to come off well in accounts of this time. Both have looked past each other, failed to grasp contrasting viewpoints, misunderstood meanings, and misread intentions.
A more cynical view might say that they have not; that this is the way the money dance is done. They understand each other, but engage in public theatrics to secure and press their relative advantages.
Regardless, what happened is worth examining at face value.
From the Chinese perspective, the government says it took steps to rein in the excesses of capital participation across a number of industries. These steps ranged from a clarification of anti-monopoly regulation in some, to the banning of profitability in others.
The reaction of the country’s stock market regulator to the subsequent selloff by foreign investors suggested the Party might not have properly considered the consequences of its actions: A meeting between the deputy head of the CSRC and some captains of foreign finance was arranged to soothe nerves; state media jumped into the fray by identifying a great buying opportunity; and the National Team pumped money into the markets to walk its talk.
From the foreign perspective, traders say they were truly shocked to discover that areas of the Chinese economy where they had assumed their capital was welcome were no longer so. Goldman Sachs says many clients started brandishing words like “uninvestable”. What they heard was obviously different from what the State Administration for Market Regulation thought it had said. To these foreigners, the banning of profits in an industry was tantamount to the ending of capital participation in that industry. More than a few found this unfathomable and extrapolated its impact.
Not every foreigner drew such dire existential conclusions, however, with some seizing a put opportunity, quickly followed by a call. To these and those on the Chinese government side overseeing the smooth flow of foreign capital into the country’s markets, it would probably be better if the entire affair is written up as yet another brief, albeit big, cross-cultural misunderstanding.
But, to paraphrase Deng as he walked up a hill in Guangdong on his 1992 “southern tour”, there is no turning back now.
Understanding the Party Line
To properly assess what, exactly, China has “clarified” about its plans for the permitted use of foreign capital in the economy, it seems a Wechat post from Chairman Rabbit is required reading. Otherwise known as Ren Yi, the Princeling with more than 2 million followers says that, in order to invest securely in China, foreign investors need to understand the government’s priorities, and carefully avoid companies that fall into any of seven broad categories. Edited for clarity and length from the original Chinese, these are:
- Those that think they are too big to fail, and therefore disregard regulatory authority;
- Those whose operations flout the government’s concerns for national security;
- Those engaged in specific industries that are important to people’s livelihood, such as education and training, which require “special logic” in supervision;
- Those that threaten the development of small and medium enterprises, on whose side the government will always be;
- Those that do not prioritize workers but instead place management concerns above all;
- Those involved in the promotion and dissemination of ideology and cultural norms; and
- Those that do not care about traditional morality or values.
If this list reads like the antithesis of how a typical foreign investor analyses investment opportunities, that is probably because it is.
Although #1 sounds like what many believe the FAANGs have become, and #2 is why the US government has a screening team called the CFIUS, all seven look similar to what Peter Thiel lays out in his book, “Zero to One” as reasons to invest in a business. In other words, if a company meets these definitions, corner its stock.
That might be an exaggeration. But neither should it be assumed that Chairman Rabbit is being sanguine. He goes on to explain why foreign investors must accept what he is saying as Party gospel:
The values of the Chinese Communist Party have not changed, but the current prioritization/”focus” has changed, the focus has shifted, and it has returned to something more original. The leader [President Xi Jinping] pointed out in his speech on the centenary of the founding of the party [July 1]:
– “The Communist Party of China always represents the fundamental interests of the overwhelming majority of the people, in solidarity, in life and death, without any of their own special interests, and never represents any interest group, any powerful group, or the interests of the privileged” .
This is actually the party rewriting and propagating its own values. This value is consistent, not a new invention, but its original intention and mission. Now that we have reached this stage, and everything is relatively mature, we must re-state and return to this original intention. Enterprises, society, and the market must be able to see this.
Those captains of the financial industry who were called into a Zoom meeting with the CSRC’s Fang Xinghai on Wednesday might have had it explained to them in a similar way. Fang probably used an abridged ppt version of Xi Jinping Thought to convey why foreigners alarmed by recent regulatory changes are mistaken to think China no longer welcomes their capital.
Chairman Rabbit might have gone a step further, however, in trying to contextualise what happened this week:
The author believes that this pursuit of protecting vulnerable groups is no different from left-wing party politics in the West, including left-wing politics in continental Europe, and left-wing politics in the United States (especially progressive politics). What the Chinese Party wants is also what the Western Leftist Party wants.
Much as this might be spot on, and an inconvenient truth for Western investors to hear, what Chairman Rabbit and the Party leadership seem to miss is that Western investors are not accustomed to allocating capital in support of government plans. On the contrary, the biggest have legions of lobbyists who seek to influence those plans, and are focused at all times on how they might benefit from, rather than contribute to, them. Moreover, foreigners need such guidelines to be more specific, and until now, they had been under the impression that the exhaustive “negative list” from the NDRC and MofCom was sufficient to plan their year ahead.
Having said that, a quick read of Bloomberg and Reuters this week might justify Chairman Rabbit forming a reassuring impression of foreigners. Analysts at reputable global institutions were quoted as saying things like: “It is best to understand where the Chinese government wants us to invest, and allocate accordingly.” Volumes of detailed analysis of the 14th Five Year Plan are likely to spew out of investment banks in the coming days, if they haven’t already.
Or perhaps both Chairman Rabbit and Fang Xinghai noticed that Citigroup took the opportunity of the three-day selloff to increase its stake in Hong Kong Exchanges and Clearing (0388.hk) above a disclosable 5%. This is a foreign investor that has clearly decided to focus on the smoke signals coming out of one capital city while ignoring those from another, assuming that Chinese IPOs are going to continue to pour into Hong Kong and away from New York without the SEC caring.
Still, not every foreign investor is as rapaciously blind to political change. And, more importantly, the administration of US President Joe Biden almost certainly is not. If strategists in Beijing believe that what they pulled this week hasn’t caused their counterparts across the big puddle to huddle, they are in for a jolt once the inevitable response comes.
From Washington’s perspective, it seems easy to perceive that business as usual is over in China. This matters. American companies might like to think they can burn capital at will in risky overseas ventures, such as “edtech” startups revolutionising how Chinese kids swot for exams, but they tend to underestimate how differently their government views the world. When Biden’s national security team looks at what happened this week, it won’t likely be with joy over the Party’s reinforcement of its left-wing credentials. It will likely be with alarm over what the destruction of foreign capital by diktat in at least one industry means for foreign investment in all others.
Restrictions on American investment into Chinese companies, or corporate and sovereign bonds, just became a lot likelier.
Right, and now for something completely different
If that wasn’t enough for foreign investors to fret about, it is also worth mulling Chairman Rabbit’s guidance on what to expect next.
The most important change, he seems to be saying, is in the definition of what it means to be an investor. Socialism With Chinese Characteristics has, since Deng Xiaoping coined the term, been interpreted by most foreign investors as the opposite of socialism. No longer. The takedown of the education and training sector, wiping out tens of billions of capital overnight, is not a leaf from any pseudo-socialist’s playbook. Neither are the guidelines given to Tencent and Meituan about how to invest their capital. Or any of Chairman Rabbit’s seven criteria for responsible foreign investors. Especially that last one.
Assurances that the Party only intended to destroy one industry, not them all, might have had a chance if the execution of the Party’s intention had been relatable for foreign investors. But because the Party asserted itself this week in a way that only Leninists could, it will be hard to erase the trauma from foreign investors’ memories the next time they get a whiff of something similar happening in another sector.
Admittedly, that is mostly due to their own laziness. This is not the China most foreign investors have grown accustomed to, where warnings are issued, investment bank compradors say not to worry, it will all blow over, and then it usually does blow over. It should not be a shock when the Party leader gives a fiery speech, followed days later by action on what he has promised, when months of Xinhua commentaries have been available for anyone to read in the leadup to this point. Xi has been telegraphing his ambitions since at least 2013.
Still, saying this after the fact doesn’t make it easier for foreigners to get to grips with the fundamentals of this change. It will take time to understand the implications of China course-correcting by going back to its 1949 roots.
To be sure, this is no longer Deng’s China. It might not turn out exactly like Mao envisaged – hopefully not – but it seems increasingly clear that it was only briefly Jiang’s or Hu’s China, and it is either going to become Xi’s or whatever he can best make of his efforts.
Spreadsheet models won’t help foreign investors get this. Neither will fireside chats with the CSRC. They will need to start reading Jude Blanchett’s explanation of why Xi is in a rush, in Foreign Affairs; listening to Kaiser Kuo’s Sinica podcast interview with Yong Cai on China’s population conundrum; and scroll through a few of this week’s bottomless Sinocism newsletters. And then they can hire a political analyst on the GLG or Guidepoint platforms. Or, if they are as rich as Citigroup, they can listen to what Kissinger Associates should have been telling them.
Once that has been taken care of, the next step is to acknowledge that all companies invested in the Middle Kingdom, local and foreign, are henceforth expected to behave as Non-Excessive Profit-Making Organisations. This will be harder for foreign investors to accept. Theoretical stuff at a high level is fine for most MBA grads, but changing the x-times profits column on their calculations because Tencent needs to take better care of the country’s “Lie Flat” generation is a tough ask. They might say they are into this, but it shouldn’t surprise anyone to see how fast their wallets disappear when it is time to pony up some collateral.
Even once all this has been done, it could still be too little, too late. At some point, someone at the White House is going to realise that they need to get ahead of this story. It is only a matter of time before Fox and CNBC start squawking that investing in Chinese companies equals investing in China’s 14th Five-Year Plan. Put more bluntly, American capital will be portrayed as having been given only one choice: Arm the competitor.
For how much longer is that going to be accepted in Washington? Biden is already talking about a cyber war causing a shooting war. It seems highly unlikely he is going to let this one slide.
With the “what” having been firmly established, attention needs to turn to the “when and where” of what comes next. But this is too detailed for inclusion here today, in what is already a long diatribe. More to come next week, with a potential area of focus being cross-border e-commerce, where Amazon has opened a new front in Cold War II.