Interview

«I think There Has Been Some Kind of Quiet Internal Revolt Against Xi Jinping’s Personal Rule»

Beijing abruptly lifts the Zero-Covid policy and takes a more business-friendly course. What is behind these moves? How do they impact the economic outlook for China? And what does it mean for investors? To find out, The Market spoke with China expert Anne Stevenson-Yang.

Christoph Gisiger
Drucken

Deutsche Version

China surprises again. Just a few weeks ago, all the signs indicated that head of state Xi Jinping had cemented his power and that pro-business forces were continuing to retreat. But now the government is reversing various policy measures taken by Xi, abandoning the Zero-Covid regime and expressing sympathy for private companies.

What’s behind this change of direction? What does the great re-opening mean for China’s economic outlook? And what are the implications for investors?

That’s what we asked Anne Stevenson-Yang. She has lived in China for more than 25 years and is one of the most renowned Western experts on the country. Her research boutique J Capital is closely observing the economy in the People’s Republic and specializes mainly in ideas for short bets.

In this in-depth interview with The Market NZZ, Ms. Stevenson-Yang shares her thoughts on recent political developments in Beijing, the state of China’s economy after the collapse in the real estate sector, the strained relationship with the United States and the recent rally in Chinese Internet stocks like Alibaba and Tencent.

«I think the new year will bring us more political conflict in China, and that means policy will be confusing, contradictory, and unpredictable»: Anne Stevenson-Yang.

«I think the new year will bring us more political conflict in China, and that means policy will be confusing, contradictory, and unpredictable»: Anne Stevenson-Yang.

The situation in China looks pretty disorganized after the abrupt lifting of the Zero-Covid policy. What are you hearing from your contacts on the ground?

There isn’t a lot of information coming out of China, which makes it very hard to figure out what’s going on. We never have any information about domestic politics, and now there is such a scarcity of information generally that I can only connect very few data points. But I have to say I think there has been some kind of quiet internal revolt against Xi Jinping’s personal rule.

What do you specifically mean by that?

Going into the 20th Party Congress, everybody expected that there would be a Standing Committee balanced between Xi allies and others. As we know, that didn’t happen. They all turned out to be Xi allies. But then, the protests broke out, and for the very first time I ever heard of in China, at least since 1949, people generally criticized the government and the CCP and demanded that Xi step down. That’s truly new and highly dangerous for the party.

How did China’s national leadership perceive Xi Jinping’s power grab?

Think of all the ways in which Xi must have offended the blooded elites: Xi seems to have inserted his own slate of «selectees». The former president was escorted out of the big party meeting in front of cameras and in front of his own son, and no one even looked at him, much less stood up to assist. There had been a couple of arrests and harsh sentences for very high-ranking officials. That’s why I think that these recent developments must have been a bridge too far for Xi’s supporters.

And why do you think it came to pushing Xi aside?

A whole lot of signature Xi policies were immediately reversed. As you saw, the Zero-Covid policy was simply dropped. The same goes for policies on loans concerning stalled property projects and policies on tech companies. All of a sudden, the government started to make positive noises about private companies. They also invited Australian foreign minister Penny Wong and a top US official to China, basically extending an olive branch to other countries. So clearly, all of these signature Xi policies have been reversed 180 degrees. It’s also noteworthy that at the China Economic Work Conference, a top-level meeting in mid-December, they didn’t mention slogans like «common prosperity» which is another key Xi policy. That makes me believe something very important has happened politically to reverse Xi’s power.

Is Xi Jinping still in power in his function as General Secretary and State President?

He’s definitely still there, and the media constantly tells us the importance of Xi Jinping Thought on Socialism with Chinese Characteristics. But I think it’s not a Xi policy government anymore. It’s also interesting that he went off to Saudi Arabia in early December, and all this turmoil happened when he was gone. You don’t leave the country when you have such massive and threatening protests. I see that as face saving: Xi had all these meetings suggesting that the Saudis are going to price some of their oil sales to China in renminbi, and that this is going to be a big progress for the internationalization of the Chinese currency. Yet, everybody knows that the internationalization of the renminbi is a dead letter, and has been since 2016.

Now that the Zero-Covid policy has been lifted, what’s next for China?

What I find remarkable is the speed and the chaotic nature of the dismantling. The same thing happened when they put together the «Zero Covid» system in the first place. My theory is - with very little basis - that this whole apparatus was an attempt of the central government to exert greater control over local structures. Since these are new structures and they undermine the local structures, the whole thing basically collapsed when it was dismantled. The enforcement force, all those guys wearing white hazmat suits, just disappeared and melted into the background. The testing regime disappeared as well; all the testing tents were folded up, and they scrapped the mandatory Covid app on mobile phones.

A gigantic Covid wave is now sweeping the country. Stocks of some funeral companies are rising rapidly. How are the people in China getting on?

There is no proactive distribution of fever medicines, at-home tests or anything like that. So we’re not going to know how many people have Covid or have died from Covid until we have census information on excess deaths. What I do know is that the vaccination rates are pretty low among the elderly. That’s dangerous. The original stance of the Chinese government was that elderly people should stay home, and young people should get vaccinated because they need to go to work. As a result, people got this idea that if they stayed home, they would be safe. That might be a reason why vaccine hesitancy still runs deep in China. I can’t tell you how many people I know who refused to have a vaccination because of some sort of pre-existing condition which basically everybody over seventy has. And those are exactly the people who should be vaccinated. Because a lot of people have only just started their course of vaccinations, it will take months to get vulnerable populations protected from serious illness.

What do these developments mean for the outlook on the Chinese economy?

It’s obviously a positive development that many of Xi’s signature policies are being reversed. When people come out of their long hibernation enforced by the lockdowns, they are going to have a lot of savings and spend a lot of money. But this will be brief. There hasn’t been any consumer stimulus in China, and there is a lot of unemployment among rural people. So you will likely have a bump in the markets because of all these policy reversals, but it won’t have a lasting effect.

How come?

There is a fundamental contradiction in the Chinese political system which makes it impossible to increase economic growth in any sustainable and healthy way. That’s why I think China is kind of stuck.

What kind of contradiction do you have in mind?

It’s well known that a tremendous portion of the Chinese economy, especially since 2009, has been driven by real estate, and that’s where something like 70% of household wealth is. In addition to that, around 20% to 30% of the Chinese economy is based on real estate, if you include materials like cement and steel and activities like construction. Because of steady price growth, they’ve overbuilt heavily. It’s a giant bubble, and the reason it lasted for twenty years is essentially because the government has been terrified of bursting it. They allowed banks and shadow banks to keep rolling over bad loans. Xi tried to stop that in 2020, and then, of course, you had the default of Evergrande and other big real estate developers in 2021.

Hasn’t this cleanup process gradually come to an end?

I don’t think so. What happened initially was that the big developers turned to pre-sales, so the proportion of cash developers took in from selling developments 18-36 months before they were built rose very dramatically. But a lot of these apartments haven’t been delivered on schedule. People who made downpayments and continue to pay mortgages started to get really angry. The government tried to deal with this in a lot of different ways, but fundamentally what are you going to do? These developers took the money and went away. What this means is that people are not willing to pre-pay anymore, and the government simply isn’t going to increase the loans to developers by enough to cover the gap. That’s the core problem: Property is not going to recover, and if people don’t see the prices rising and companies completing their real estate projects, then they are not going to buy.

How is the crisis in the real estate sector affecting domestic consumption?

During the long years of the real estate boom, you had all those secondary effects. For example, because property was rising in price, local governments wanted to buy more land and develop more property. So they bought land-use rights from people and that money in people’s pockets boosted consumer spending. Lots of new investment products saw explosive growth from the money that essentially came from real estate sales to the government. So that ends. That’s why you see automobile and appliance sales decline. Gambling is never going to recover, or at least never to the rates it was growing in 2012 and prior. That’s the real problem: There is too much real estate in China, and it’s overpriced. There’s not much you can do about that other than to gradually absorb the losses, which means decades of flat growth or even reversal of past gains.

Is there no other way for China to get back on a path of robust growth?

It’s important to be aware that China is really two countries: You have a fairly prosperous nation along the coast, and then you have a billion people in the interior who are there essentially just to supply cheap labor to the coastal cities. Since the coastal cities have not paid the full cost of that labor in terms of education, healthcare and pensions, their economies have looked very buoyant. In contrast to that, the health and education of the people in the interior is at a level similar to Algeria’s. Social well-being is definitely worse than, say, Malaysia. So if you were to raise those people out of poverty and sort of blend them with the 350 million on the coast, you would drag down growth for everybody. And if you were to leave them out entirely, you basically split the country.

So the risk of further political tensions remains high?

That’s true. Think of how much disruption to the international economy and to world politics the unification of Germany created in the 1990s. But now, you have something that’s ten or twenty times as large as that, and the income gap between internal China and coastal China is greater than the income gap between East Germany and West Germany at the time.

With this in mind, what kind of growth rates can we expect for China in the next few years?

That’s hard to tell. But it’s typical that at the end of investment-driven booms you have growth dropping into the 1% region for quite a long time. Another problem is that there is an awful lot of economic pain that you don’t see. In lots of localities in China, local governments are out of money, so they are closing hospitals, schools and bus lines. That’s a real hardship for people, but it’s something that we don’t see internationally.

At the same time, tensions in foreign policy are also on the rise. How do you interpret the latest developments in the dispute between China and the USA?

One of Xi Jinping’s great missteps has been his handling of relationships internationally. To be fair, it was destined to happen anyway, but it was accelerated by his foreign policy. Supporting Russia back in February was a big mistake. It didn’t really gain China anything, and it antagonizes many foreign countries. You also have to keep in mind that US policy is driven more than anything else by defense and thoughts about defense. So there was a lot of anxiety in Washington once China supported Russia and made hostile comments about Taiwan.

On an economic level, the conflict has already escalated this fall with a drastic tightening of US sanctions against China’s semiconductor industry. How will Beijing react to these measures?

China has decided to challenge the US chip export restrictions at the WTO. I don’t know that this will be successful, as the US defines it as an issue of national security, which is not in the WTO’s purview. And the US is going around the world trying to get support from other countries. Anyway, I think that the damage has been done. When it comes to multinational corporations, everybody is looking at how to reduce their exposure to China by shifting portions of their value chain to other countries. They’re all studying this. Then, you have the fact that a lot fewer foreigners and visa holders are in China than there were prior to 2016, and certainly prior to Covid.

What are the implications of that?

Foreign companies have a trust gap, which means there is a much slower development of new investment and less transfer of skills. As a result, you are going to see a lot of exploration of Vietnam, Malaysia and India as destinations for investment rather than China. That’s sort of a done deal, no matter what China does on the chip sanctions.

Do you mean, for example, Apple’s efforts to relocate production from China to other countries?

Apple is a good example because they’re putting more production into India. They talked about reducing their exposure to Foxconn’s Zhengzhou plant, the world’s largest iPhone factory. They’re spreading their value chain around, which is smart. Certainly, that’s been happening across all sorts of different sectors in the United States. Companies are looking for ways to reduce their exposure to China. Covid exposed a lot of these problems: for example, PPE is all coming from China, so we had no masks here in the US. The same thing is true for chemicals that go into drugs. One thought that globalization improved the efficiency of value chains, but it actually made those value chains much more brittle and vulnerable.

Similar problems exist with semiconductors when you think about the complicated relationship between China and Taiwan. How great is the risk of a military conflict?

I don’t know. It would be really not smart for China to invade Taiwan, but people do really not smart things all the time. One hopes that the invasion of Ukraine, which is going so badly for Russia, is going to be a good warning against China doing the same thing: To spend twenty years in a ground war against people who are seen as Chinese is not going to be popular with Chinese soldiers.

How do you think the relationship between Washington and Beijing will evolve now?

The US Congress certainly is not well disposed toward a relationship with China. But here’s the deeper question: What is it to be gained from having a better relationship with China from an US point of view? That’s a lot harder to answer than it was a few years ago. It’s interesting that the United States has become so much more confident and self-assertive. We have NATO strengthened, and competing powers essentially going away in terms of the international picture. A lot of people were expecting a new unipolar world to emerge with China on the rise and the US declining in power. But really quite the opposite has happened.

What does all this mean for investments in China? For instance, Chinese internet stocks such as Alibaba and Tencent have staged an impressive rally since the end of October.

Alibaba and all of the Chinese internet stocks were essentially growth stories. They were driven by the idea that Chinese consumption was going to grow and that it would increasingly go online. Therefore, these companies would be hugely dominant in the future. I’ve never been a fan of Alibaba. It’s true, the company has tremendous uptake in its core China commerce, but it has all sorts of dark corners. There are lots of things they don’t tell you about. Alibaba is clearly falsifying a bunch of financial statements, but I would never touch it as a short. Because when you’re a black box, what can any external player do? The same is true of Tencent.

Then again, there is hope in the markets that the regulatory environment for Chinese tech companies will change for the better.

It could change, but I’m not sure it’s going to make much of a difference. What was really negative for the tech companies last year was China’s focus on security and individual information. It was also shocking how they would strike at a company like Didi and crash the stock without warning. These interventions have been very negative for the Chinese listed companies generally. But even if they ease off the regulatory regime, it’s not going to make the economic environment any better. Alibaba and Tencent are huge companies, but they are more banks than they are e-commerce companies - and the banking environment externally is not good for them anymore.

In general, sentiment toward Chinese equities has shifted noticeably in recent weeks. What do you think, is China «investable» again?

It’s true, sentiment really switched very rapidly. As I mentioned earlier, I think we’re going to see a bump in consumer spending towards the end of February or in March and this will help the sentiment around Chinese stocks. Many have backed off plans to delist in the US, and it’s clear that China’s policymakers are extending an olive branch. But China’s economy is not going to recover overall. Analysts and investment banks love to have something to be enthusiastic about because their job is to sell stocks and debt. So they get all excited. Take commodities for instance. I can’t think of anything positive for the commodities world except possibly lithium and nickel because they go into electric cars. But for iron ore, copper or aluminum, there is nothing positive to say, because Chinese real estate is not going to recover.

So what’s the most important thing for 2023 when it comes to investing in China?

The main thing we’re going to see is volatility. Whatever has happened politically, there’s no strong direction or consensus. I think the new year will bring us more political conflict in China, and that means policy will be confusing, contradictory, and unpredictable.

Anne Stevenson-Yang

Anne Stevenson-Yang is a co-founder of J Capital Research and is J Capital’s Research Director. The firm publishes high-diligence research reports on publicly traded companies. Founded late 2010 in China, the company has particular expertise in the Chinese market but looks at overvalued companies throughout the world. Ms. Stevenson-Yang was formerly co-founder of a group of online media businesses in China and also founded and operated a CRM software company and a publishing company. Over 25 years in China, Ms. Stevenson-Yang has also worked as an industry analyst and trade advocate. She authored the 2013 published book «China Alone: China’s Emergence and Potential Return to Isolation», arguing that China historically repeats a cycle of expansion and retreat. A new and updated edition is planned for this year. She periodically shares her thoughts on current developments in the People’s Republic in a column for «Forbes» and as an op-ed contributor for The Market/NZZ. We recommend her essay for Mekong Review titled «Keeping the flies out» which was published earlier this year.
Anne Stevenson-Yang is a co-founder of J Capital Research and is J Capital’s Research Director. The firm publishes high-diligence research reports on publicly traded companies. Founded late 2010 in China, the company has particular expertise in the Chinese market but looks at overvalued companies throughout the world. Ms. Stevenson-Yang was formerly co-founder of a group of online media businesses in China and also founded and operated a CRM software company and a publishing company. Over 25 years in China, Ms. Stevenson-Yang has also worked as an industry analyst and trade advocate. She authored the 2013 published book «China Alone: China’s Emergence and Potential Return to Isolation», arguing that China historically repeats a cycle of expansion and retreat. A new and updated edition is planned for this year. She periodically shares her thoughts on current developments in the People’s Republic in a column for «Forbes» and as an op-ed contributor for The Market/NZZ. We recommend her essay for Mekong Review titled «Keeping the flies out» which was published earlier this year.