I wanted to do this as a flow chart, but my lack of experience with the flowchart tools (and my lack of patience) ended that gambit. So, for now, we will just write about what I think is happening (and will happen) in the shortest possible way.

Does China Have an Economic Problem? Yes

The Chinese economy is in the doldrums. Their stock market has done nothing for decades. Real estate, the major source of wealth for many, has been floundering badly. Youth unemployment, even amongst STEM students, is running high. There is nothing about their demographic (an aging, shrinking population with a high male to female ratio) that puts China on the path to growth.

Does the CCP Need to Care? Yes

There are plenty of problems to be solved in China, but fixing all of them is not critical for the CCP to remain in power. My working assumption (supported by Academy’s Geopolitical Intelligence Group) is that the Chinese Communist Party’s primary goal is to remain in power. How that impacts its citizens is a byproduct of their efforts to retain strict control over the nation.

The burgeoning (or maybe more correctly, the once burgeoning) middle class potentially poses a threat to retaining that control. This class, concentrated in major cities, could have enough power and influence to reduce the power of the CCP (in contrast to the largely poor rural population, which while larger in number, doesn’t embody that sort of threat to the CCP).

We saw this when China went from COVID 0, to COVID “All Gone.” Remember, in a short time, the government went from trying to retain lockdowns, to suing some countries for not allowing their citizens to enter without testing.

This is crucial because everything else hinges on agreeing with the next point.

The weak economy poses a threat to the reign of power of the CCP and since they see that too, they will attempt to address it. If you don’t agree, then you are free to stop reading.

Options for China to Get Back on Track Economically

I am sure that there are many ways for China to attempt to get back on track, but I see 3 main ways.

• Can They Become a Consumption Driven Economy? No

Even when the economy was chugging along, and many of us were expecting China to make the transition to a consumer driven economy, it never really materialized.

• The Chinese desire to consume is nothing like the American desire to consume. To be fair, no one in the world seems to be as consumption oriented as the U.S., but it still doesn’t seem to fit the culture of the Chinese consumer, so while domestic consumption will help short-term, it is unlikely to be the ultimate solution.
• The aforementioned demographics do not bode well for consumption. An aging population just isn’t as likely to consume enough for China to be self-sustaining.

• Can They Become the World’s Factory Again? No

That ship has sailed for many reasons.

• Concerns surrounding intellectual property make every company cautious about manufacturing in China going forward. The risk of losing intellectual property (on the good itself, or related to the process of making or designing that good) is real and something companies are very cautious about, especially regarding any new investment in China.
• Shipping is a specific example, but complete control by the CCP is an overriding issue. No one can forget not being able to ship their goods out of China during the initial lockdowns. It demonstrated the complete control of the CCP in a way that many had not thought (or even imagined) possible. It is extremely difficult to invest in new production there, because if something does happen, it will be extremely difficult to defend yourself by arguing “no one saw it coming.”
• The markets were never fully opened to foreigners like foreigners thought, hoped, or were led to believe. If you don’t think you will be given free and fair access to China as a market, the propensity to invest and build there is much lower. That carrot played a big role in attracting companies there, but this just doesn’t seem to exist now.
• While not the primary concern, companies are worried about “stranded assets” or “how to get their money out of China,” which will make them less willing to increase their activity in China.

• Can They Sell Their Own Brands Domestically and Abroad? Maybe

This is our Threat of Made by China argument. It is unclear that it will be successful, but it seems at least plausible that it could work.

• Chinese brands are doing very well domestically. They seem to be doing well in many cases. While doing some searches, it looks like Chinese brands (Huawei, Honor, Xiaomi, OPPO, and Vivo) are now outpacing Apple sales in the smartphone market (did you know that there were 5 companies doing that in China?). Even COMAC, while only having 9 planes in service, is up from 0 (18 months ago), which seems to be a “good” start for them in an incredibly difficult area to get any traction. China has the ability (and likely the will) to drive domestic consumption to their own brands, either subtly or obviously.
• China is also making strides globally with their brands. Apparently BYD is the number one selling EV in Germany of all places. Chinese EVs are not the first thing that comes to mind when I think about the Autobahn. In India, it looks like Vivo and Xiaomi are near or at the top in terms of market share. Even COMAC has found one international carrier (a low-cost Indonesian carrier) to fly its planes. China is making inroads, even in more economically developed nations.

The Plan

1. The economic problems facing China are a threat to the power of the CCP.
2. They will use stimulus to get some wealth into the hands of their consumers.
   1. The primary goal will be to boost sales of domestic brands and hence create more domestic wealth (through share price appreciation) and jobs at those domestic companies. The more that is spent on domestic brands compared to foreign brands, the more bang for the buck they will get from their spending. They want to create a positive feedback loop by getting the domestic consumption going, and focusing on domestic brands.
   2. Their energy industry, including their sustainable energy projects, will do well too. Chipmaking is improving, so they might develop new areas to compete with “us” globally on the back of domestic growth. They want to create a positive feedback loop, by getting the domestic consumption going and focusing on domestic brands. I repeated this on purpose as it is critical to what I see as their plan.
   3. Chinese brands will continue to try to sell their products globally. Yes, they will face hurdles from protectionist governments and issues with brand recognition in many parts of the world, but China Inc. (the combination of the government and Chinese companies) is quite powerful. The stimulus is more about buying China time to further develop these sales and product offerings, rather than directly helping them.
3. Evaluate success.
   1. If successful, they can end stimulus.
   2. If unsuccessful, go back to step 2 with more/different stimulus (again, depends on if economic malaise is really a threat to the CCP’s dominance).
   3. If unsuccessful and going back to step 2 is not an option, then what? I think we are a long way from this stage, but it is likely not going to result in a decision that is good for global peace and harmony.
      3. If we get here, I could see anything from the government attacking the Variable Interest Entity (VIE) structure to hurting foreign investors by stopping payments out of China. Certainly extreme, but we are not at 3.c.i because things are still going China’s way. Other actions to favor domestic investors over foreign investors (basically wealth transfer) could be employed if we end up here. Finally, is this the stage, if we get there, that military action looks appealing as a way to distract the nation?

Bottom Line

Expect stimulus. I don’t spend much time worrying about the exact nature of the stimulus, because I think their plan will evolve and develop over time.

If the stimulus doesn’t do enough to stimulate domestic consumption, then expect another round of stimulus.

The stimulus will be geared to create domestic wealth, through property and even stocks, so don’t bet against stocks.

We are still in the “tradable” range of outcomes. This is just the first of potentially many iterations where step 3 (evaluation) takes us back to step 2 (more/different stimulus).

Ultimately, this may reach the stage of being un-investible, but we are a long way from there!

The market got too far ahead of itself as discussed in this weekend’s War, Inflation, and the Neutral Rate, as a lack of liquidity in general coupled with a market that was officially closed for a week pushed the main ETFs that I follow (FXI and KWEB) too far.

But now, start adding, and if you think Don’t Fight the Fed is rational, you should probably agree to following a strategy of Don’t Fight China Inc.

Probably too simplistic, and I do think a flowchart would be a better way to present this simple view, but I think the simplicity works and leads us to the correct expectations on how this will play out.

DISCLAIMER