Introduction
Investing in China’s economy or companies primarily operating in China could bring serious risks to investors. Not only is the company facing a mounting real estate crisis, but the Chinese government is likely running out of options that could effectively address the economic risks as a result of the country’s unique political concerns. Further, as a result of global corporations diversifying away from China due to political and economic reasons, the current economic slowdown in the real estate sector could be amplified. As a result, I strongly believe that investors should consider the risks associated with investing in Chinese stocks such as Alibaba (BABA), Li Auto (LI), and NIO (NIO) while also being cautious of companies with heavy exposure to the Chinese market such as Apple (AAPL), Nike (NKE), Starbucks (SBUX), Tesla (TSLA), etc.
Government’s Sweeping Resolution Likely Not Possible
In the modern world, the government’s sweeping resolution to an economic crisis either averted or minimized the magnitude of the economic crisis. The biggest and the most recent example of this claim could be found in policies that came out shortly after the pandemic started. To minimize the magnitude of the economic pain, global governments imposed an extremely loose monetary and fiscal policy. Looking solely at the United States, the Federal Reserve started quantitative easing at an unprecedented level while the US Government enacted supportive fiscal policies including pausing student loan repayment, multiple stimulus checks, and more. These actions arguably led to a short economic pain resulting from the pandemic followed by a period of strong economic growth. The pandemic is not the only time a government body has intervened in times of economic crisis. The 2008 Financial Crisis also saw a loose monetary and fiscal policy in an attempt to shorten the recession. As such, I believe it is reasonable to argue that the modern world and the ideas of modern monetary theory, and quantitative easing, brought a world where investors expect the government to quickly intervene to solve an economic problem as it has been effective thus far.
However, unlike the US and potentially other Western countries, sweeping government intervention like quantitative easing and loose fiscal policy is likely not an option for China during the current economic slowdown potentially prolonging the pain.
China has intensive political capital on achieving common prosperity since 2021. President Xi has repeatedly emphasized the importance of achieving wealth together instead of being focused on just a select few. Beyond the speeches, his administration has enacted numerous policies to support this vision. First, there was a widespread ban on private tutoring of any kind to create a more equal education environment. Then, there were strong anti-monopoly laws to limit the powers of a few corporations that have garnered significant power. The biggest example of this law was when Ant Group, a Chinese Fintech Company, paid about $984 million in fines. As such, President Xi and his administration have invested significant political capital over the past few years making a new policy that could hinder this vision unlikely to occur.
As discussed earlier, to shorten the magnitude and the timeframe of the economic slowdown, a loose monetary and fiscal policy is needed. Unfortunately, history has shown that quantitative easing and loose fiscal policy result in a boom in the financial markets, which includes the real estate and the stock market. As it is the case that these results in a greater wealth gap, I believe it will be extremely difficult for the Chinese government to enact an aggressive policy to support the economy. So far, China is lowering interest rates at a painfully slow rate of 10 basis points or a hold, which, in my opinion, supports my thesis as the government is not enacting a strong policy.
Therefore, I believe the current slowdown in China’s economy will inevitably be prolonged. There are not many things a government can do in the current situation in terms of fiscal and monetary support.
Why Common Prosperity
One might argue that if the economy is the problem, why not track back on the common prosperity goals for a short term to focus on supporting the economy? After all, couldn’t the Chinese government simply come back to these goals later?
This is likely not the case. I believe President Xi is pursuing common prosperity as a greater wealth gap often leads to a revolt or a revolution. It has been made clear that President Xi longs to be the leader of China for as long as possible after President Xi secured his third term in office graduating from the previous two-term tradition. As such, it is likely, in my opinion, that he views an accelerating wealth divide to be a risk factor to his staying in power.
The International Monetary Fund, IMF, reinforces this idea. According to the organization, “excessive inequality could erode social cohesion, lead to political polarization, and ultimately lower economic growth.”
China, today, is an authoritarian country with its leader, President Xi, securing 5 more years as the country’s leader in 2023. As such, with a significant time left until the potential for a regime change, the focus of President Xi’s administration for the longevity of its reign could be on long-term political and societal stability over the short-term economic gains garnering support for the common prosperity agenda.
Potential Impact
While the long-term prospects of the common wealth agenda could be positive, in the short-term, economic pain could occur in numerous industries within China heavily affecting companies primarily operating in China.
First, China is already starting to see deflationary pressure as the country saw the steepest decline in consumer prices in 14 years as the price of consumer goods saw a 0.8% year-over-year decline. This figure is shocking as Japan, a country that has been undergoing deflation and slow growth in the past few decades, is seeing about 3.2% consumer price growth year over year.
The implications of a deflation in China’s economy will likely be staggering. Consumers will first slow down spending creating a snowball effect of further deflation. If the price of goods keeps coming down, why spend today when tomorrow will be cheaper? This expectation could lead to a slowdown in spending followed by a deeper deflation along with a deeper cut in spending, which has already started to happen in 2023. “Chinese households have added 13.8 trillion yuan ($1.89 trillion) in savings in the first 10 months of the year, an 8.5% increase from the previous year.”
As consumer spending slows along with the overall economy, numerous companies could be affected in nearly every single industry. Starting with American companies, Apple, Starbucks, Nike, Tesla and more companies exposed to the Chinese market could see a headwind coming from slower spending, which has the potential to accelerate. Further, Chinese companies such as automakers Li Auto and NIO could suffer along with an e-commerce platform company Alibaba.
The potential impact on China’s economy does not end here. Due to the slowing consumer spending, foreign investments in China have nearly stopped. Foreign direct investment in China has dropped to a 30-year low, signaling that even foreign firms are acknowledging the risks. Unfortunately, slower investment will inevitably lead to further strain on spending and the overall economy.
Overall, China’s economy is struggling today. Consumers are foregoing spending, deflationary pressure is starting, and foreign investments are leaving the country. As these are all interconnected and have the potential to snowball into a bigger problem prolonging the recovery without a meaningful government intervention, I believe the current problem in China’s economy could continue as a strong intervention from the central government is unlikely.
Takeaway
All investments come with their respective risks; however, some investments come with a greater magnitude of risks. I strongly believe that companies exposed to China, today, pose a greater magnitude of risks due to the country’s unique economic and political risks. The country’s economy is slowing with signs of deflation, declining foreign investments, and reduced consumer spending, yet the central government is unlikely to enact an aggressive policy to shorten the period of an economic slowdown due to the government’s cautious approach to common prosperity and the wealth gap amplifying the problem. Therefore, whether the Chinese government succeeds with its approach in the long term, I believe the risks associated with investing in China are too grand, and investors should take caution.
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