George Magnus is a member of the China Centre at Oxford University. Before that, he spent twenty years (1995-2016) as chief economist at UBS. So he knows both the markets and China well.

So when he wrote an article in the Financial Times a fortnight ago entitled "The risk of a devaluation of the Renminbi is real", it might make useful reading. The risk cited by Magnus is as follows: the Chinese government must lower interest rates to help the economy, and this will mechanically weigh on the renminbi.

Last year, Anne Stevenson-Yang, who lived in China for twenty years, both as a journalist and as a representative of the US-China Council, published "Wild Ride, a short history of the opening and closing of the Chinese economy". In it, she explains that the thesis that China is following the Western model has been false from the outset. The reality, she argues, is that post-Tian'anmen (1989), the Chinese Communist leadership came to the conclusion that the only way to retain political power was to offer economic growth to the people. To launch this movement, Deng Xiaoping did not pull any punches for a Communist, declaring in 1992 during a tour of the south of the country: "To get rich is glorious". This change of tone - to a command economy - accompanied by a massive opening of the credit floodgates generated a lot of growth, a lot of debt, a lot of inequality and a lot of misallocated capital. So it was a race to the front for twenty years, but the primary objective was not economic growth but political power. And from the moment there was a divergence between these two objectives, it was politics that took precedence, as shown by the muzzling of big business and the takeover of Hong Kong.

Last lines of the book:

"China is, and always has been, an ancient land with a political culture profoundly resistant to change. China's unbridled growth and its experience of Western capitalism over the last four decades were decided and implemented by the Party, which had a single goal: its survival. And the Party no longer needs the outside world. In fact, if it wants to survive it must now return China to the state of isolation that has characterised so much of its history."

I asked Jonathan Anderson, founder of Emerging Advisors, what he thought of this thesis. Jonathan is the former global emerging markets economist at investment bank UBS, where he worked for nearly ten years. Prior to that he worked at Goldman Sachs and the IMF, where he was resident representative in China and Russia. He has a master's and doctorate in economics from Harvard University and is fluent in Russian and Mandarin Chinese. So he knows his stuff*.

Here's his response: "Hi Charles, no, I haven't read the book, but the conclusion doesn't surprise me. For those on the ground, the trend is pretty obvious. The only thing I would add is that for most observers (and I suppose Anne is no exception?), the conclusion is based mainly on geopolitics... whereas, according to our own work, it is also crucial to understand that the trend is strongly dictated by underlying macroeconomic pressures and imbalances. In other words, even if relations between the United States and China were to improve and/or the domestic political environment were to change radically, China would have little choice but to close itself off further...".

Jonathan's scenarios are either China following Putin's path with Russia, or North Korea. That's his thesis: « If you want a good historical indicator of China's economic future as it enters the second decade of Xi Jinping's administration, facing a rapidly deteriorating geopolitical environment and new socio-economic challenges at home, we suggest you take a very close look at Russia, which saw its own situation deteriorate to the point of near pariah status a decade ago - and in the process went from one of the riskiest, growth-oriented economies in the emerging world to one of the most cautious and conservative, c.. - i.e. from 'Putin 1.0' to 'Putin 2.0'.

The parallels between China's current experience and that of Russia over the past fifteen years are surprisingly close, as Beijing has locked down its balance sheets and reduced its exposure to economic and social risks at the expense of growth. As a result, investors may have to fundamentally rethink the demand for mainland China and the prospects for opening up over the next five to ten years."

Conclusion: here are three different voices, well-informed on the subject, who envisage China closing in for both political and economic reasons. There are several conclusions to be drawn from this, on supply chains and on the geopolitical balance. But we can already lower the valuation of Western companies with significant exposure to China.

* Thanks again to Cyril Castelli of RCube for introducing me to Jonathan a few years ago.

 

Market and portfolio focus

Behaviour:

This week, the fund gained 0.6%, while the CAC40 lost 0.6% and the S&P500 gained 1.5%. Our exposure to US long rates accounted for a third of the performance, as did our Concentrix line.

 

Lines:

A few changes in the portfolio this week.

We entered Braze (0.5%). Led by co-founder Bill Magnuson - a truly brilliant guy who came through MIT, Google and Bridgewater - Braze is a cloud-based customer relationship management platform. Its trademark? Constantly updating the customer's marketing strategy using their mountains of data.

At the same time, we reduced our positions in Lamb Weston (3%) and Unilever (3.5%) to remain within regulatory limits.

 

Have a great week,

Charles