30 Aug 2023
The Jupiter Merlin team discuss the state of China’s economy. China’s confidence abroad contrasts with its struggles at home, as growth falters and deflation arrives.
In June when US Secretary of State Antony Blinken met his counterpart Qin Gang in Beijing to try and re-set US-Sino relations, the Chinese foreign minister and former ambassador to Washington effectively told him to mind his own business: the gist was the West needs China more than China needs the West; his message was reinforced by a demand to stop meddling in China’s territorial affairs particularly in the South China Sea and over the status of Taiwan.
In what is evolving rapidly into the Mystery of the Missing Minister, Qin has since disappeared. Or has he ‘been disappeared’? Either way, he’s gone; vanished. Though not totally expunged: he might not have been seen either in public or official circles for more than a month but as reported by Reuters, as recently as Tuesday he was still officially recorded as State Councillor by The National People’s Congress Standing Committee, and his portrait still adorns the walls of the Chinese embassy in America on the foreign ministry website. Ill? WfH? On holiday in Outer Mongolia? Undergoing re-education, perhaps, about Chinese foreign policy? Repenting at the General Secretary’s pleasure down a salt mine for becoming too popular? Who knows. But eventually all will be revealed. Reminiscent of the physical and very public manhandling of former President Hu Jintao from Congress last October (officially, the poor chap very suddenly “needed a rest, to take a break”, so he was frog-marched off the stage), welcome to the sinister world of realpolitik in a one-party state firmly in the grip of General Secretary Xi Jinping, ‘Dada’ (Uncle), officially anointed ‘Core’ and ‘Helmsman’ by the Chinese Communist Party.
If nothing else, Blinken’s embassy clearly established one thing: China sees itself in the ascendancy and regards itself on a par with the US as a global superpower. Whether it is deluding itself remains to be seen, but the intent is clear enough. And having been firmly but diplomatically rebuffed after holding out a tentative olive branch, Washington is not minded to take such hostility lying down. This week by Presidential Decree, reinforcing the legislation already implemented by Donald Trump to protect US patents and intellectual property rights, Biden turned the screw another notch and has severely limited outbound US investment targeted at Chinese technology subsectors, focusing on areas of national security including the development of AI, semiconductors and quantum computing. Under the new Anglo-US Atlantic Convention signed in June (of which AUKUS with Australia forms one of the strategic defence and foreign policy elements), the Americans are now waiting to see if Rishi Sunak follows suit. As for the EU, forget it: France’s Macron, Germany’s Scholtz and Italy’s Meloni are where the UK was in the Osborne/Cameron “Golden Era” of a decade ago (otherwise known informally and irreverently as “Kow-tow”): talking a good game about the importance of western values but in reality holding their noses over the nasty bits and happy to ride the economic coat-tails of China’s One Belt One Road infrastructure development. Incidentally, the tariffs deployed by Trump in 2018 against any country (including China) with a big trade surplus with the US which Trump deemed also to be eating America’s lunch, are all still in place under the Democrats.
But all is not well with the economic fundamentals underpinning China’s strategic superpower ambitions.
However much it has been trying to rebalance its economy away from over-reliance on exporting relatively low value-added goods in favour of domestic consumption and developing its own high value-added sectors in technology, aerospace, automotive, defence and pharmaceuticals, the recent trade data shows that China still very much needs the West. The lowest current account (the net difference between exports and imports) surplus for two years in July, and a 14.5% year-on-year decline in exports were worse than expected. Remember, leading into the end of 2022, China was still in the grip of widespread Covid lock-down and the turn of 2023 was supposed to herald the “reopening trade”, in which China’s release to normal working patterns and a restoration of growth to a target rate of 5% would drag the rest of the world up with it. The target rate looks to be a struggle. Notable in that export data was a decline of 23% with the US against a year ago, the US being China’s biggest single-nation export market. The EU and the ASEAN trading blocs were also down 20.6% and 21.4% respectively.
Also reported this week was that China dipped into deflation in July, prices falling by 0.3% year-on-year. While lower prices are good news for consumers’ purses and wallets, a persistent trend is unhelpful to achieving sustainable economic growth. Consumers tend to put off purchasing today what they anticipate will be cheaper in the future; if such a pattern endures, the corrosive effect on the economy is one of slow relative decline; a good analogy is the child’s trick of putting a pin in a balloon without popping it (the catch is the surface of the balloon has a Sellotape patch on it); rather than going bang!, it remains intact but deflates slowly. China’s inflation/deflation experience has been very different from that of the West over the past three years: it peaked at 5.7% early in 2020 and like today had a period of deflation at the end of that year and into early 2021. It is also worth noting that as the biggest net importer of oil (mostly from Saudi, Iran and Russia), and oil prices having risen 22% since mid-June, there may well be a reversal of some of those deflationary pressures feeding through in the data later this year (as has just been seen in the US July headline inflation rate which ticked up from 3.0% to 3.2%).
Two other factors also point to economic difficulty. First, almost exactly a year since the large Chinese based property developer Evergrande was close to corporate collapse, another, Country Garden, is labouring under multi-billion dollar losses and on the brink of defaulting too (‘Country Garden’ is surely a figment of a marketeer’s over-active imagination: its estate is largely vast columns of high-density urban tower blocks, barely a blade of grass let alone what we know as a countryside garden in sight). The culprit is the 30% year-on-year decline in new housing sales in mainland China.
Second, having dipped briefly to 16.7%, China’s youth unemployment rate has risen every month since December 2022 and has been over 20% again since April (21.3% today, two thirds higher than pre-pandemic).
The relevance to the world economy is simple: notwithstanding the drive to rely less on China as a source of finished goods and components (‘onshoring’), it remains the hub of international trade and sits firmly at the base, the anchor-point of most global supply chains. Until the pandemic when it was regularly growing at over 5% and approaching 18% of the world’s GDP, it was estimated that China alone accounted for 30% of every incremental point in global growth. If it falters while the US is also sluggish (and between them they are 43% of world economic activity), then global GDP struggles too.
Even in a largely supplicant society, the pressure arising from these economic factors is a potential political challenge to the CCP in general and Xi Jinping specifically as an autocrat (he was aware of the unrest arising from repressive lockdown measures and relented; he might be tough but he is not tone deaf). As a big trading economy, China cannot hide from the vagaries of international commodity prices and there are elements of its inflation/deflation cycle that are beyond its direct control. But the communist philosophy is built around the command economy; after a period of flirting with incorporating limited forms of capitalism, Xi is explicit in his intent to restore full socialist principles, albeit “with Chinese characteristics.” The extreme volatility of the property market seen over the past half decade in which tens of thousands of surplus accommodation units have been built and remain unoccupied is entirely a function of bad economic policy. A fifth of the youth population in a socialist command economy being out of work is also symptomatic of policy with substantial flaws.
Which brings us back to China’s strategic ambitions for its self-proclaimed New World Order. Time will tell whether they are affordable or achievable: as many western commentators disbelieve that the Chinese economy will surpass that of the US as think it inevitably will.
But economic size is not the only consideration. Looking outwards, China’s diplomatic tentacles are spreading; evidence includes brokering peace talks between Saudi Arabia and Iran and it again being suggested that Beijing might be the agent if not to reconcile Russia and Ukraine, then at least bring a cessation to hostilities. Elsewhere as the world transitions to the new era of alternative fuels, China is making every effort to control or at least heavily condition the supply of those natural resources which will be increasingly important to maintaining living standards: copper, lithium, nickel, cobalt and a host of others. It is no coincidence that China is investing heavily in the major geographic sources in sub-Saharan Africa and South America. Further, if a political threat were posed to the regime in Beijing thanks to unsustainable demographics, poor domestic policy planning and reactions from the West such as those seen this week, it could deflect internal criticism by falling back on the time-honoured means of nationalistic sabre-rattling to create national unity. US intelligence still estimates that by 2027 China will have the military capability to recover Taiwan with at least an evens chance of success; the starting premise of the US military is that Taiwan will be targeted by China: it is merely a question of by what means its recovery is actioned and when. China is also likely to keep up its asymmetric attrition with cyber incursions against western government and corporate systems.
China offers investment opportunities. However, western shareholder minority rights are of little or no concern to the CCP. Foreign shareholders and bondholders may be deliberate victims or collateral damage in any escalation of tariffs, sanctions, prohibitions, military actions etc employed by both the West and China as they defend their own interests. On the Jupiter Merlin team we are willing to forgo those opportunities. We try as far as possible to avoid any direct investment in Chinese companies on the simple premise that once invested, we may not be able to get our clients’ money out when we wish to, possibly even not at all. However, thanks to China’s global reach and it being the second biggest economy in the world, it is impossible not to have an indirect interest in the Chinese economy through our exposure in the funds in which we invest to the many international companies which either export to or import from China, or even operate within it.
The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.
The value of active minds – independent thinking
A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.
Fund specific risks
The NURS Key Investor Information Document, Supplementary Information Document and Scheme Particulars are available from Jupiter on request. The Jupiter Merlin Conservative Portfolio can invest more than 35% of its value in securities issued or guaranteed by an EEA state. The Jupiter Merlin Income, Jupiter Merlin Balanced and Jupiter Merlin Conservative Portfolios’ expenses are charged to capital, which can reduce the potential for capital growth.
Important information
This document is for informational purposes only and is not investment advice. We recommend you discuss any investment decisions with a financial adviser, particularly if you are unsure whether an investment is suitable. Jupiter is unable to provide investment advice. Past performance is no guide to the future. Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. The views expressed are those of the authors at the time of writing are not necessarily those of Jupiter as a whole and may be subject to change. This is particularly true during periods of rapidly changing market circumstances. For definitions please see the glossary at jupiteram.com. Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given. Company examples are for illustrative purposes only and not a recommendation to buy or sell. Jupiter Unit Trust Managers Limited (JUTM) and Jupiter Asset Management Limited (JAM), registered address: The Zig Zag Building, 70 Victoria Street, London, SW1E 6SQ are authorised and regulated by the Financial Conduct Authority. No part of this document may be reproduced in any manner without the prior permission of JUTM or JAM.