Interview

«China is Stuck in a Vicious Cycle»

Anne Stevenson-Yang, Co-founder and Research Director of J Capital, is skeptical about a rapid recovery of the Chinese economy. She spots serious problems in the labor market and in the real estate sector. She also warns of fraud at the investor’s darlings Alibaba and Tencent.

Christoph Gisiger
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Few western observers know China better than Anne Stevenson-Yang. The American lived in the People's Republic for more than 25 years. In 2007 she co-founded J Capital, an independent research firm that focuses mainly on Chinese companies and the macro environment.

Recently, data out of China's economy has surprised positively. Yet, Ms. Stevenson-Yang still sees serious problems, including high unemployment among migrant workers and growing pressure on property prices. In her opinion, the risk of a significant devaluation of the Renminbi also increases.

Regarding the trade war with the United States, the China expert notes that there is growing frustration in Beijing with the Trump administration. She’s doubtful of the communist regimes’ efforts to build an innovative tech industry and warns of investments in Chinese companies, even when it comes to internet giants like Alibaba and Tencent.

«I’m waiting for the day that Alibaba or Tencent default on their debt or decide that they are going to delist,» says Ms. Stevenson-Yang in this in-depth interview with The Market/NZZ.

Ms. Stevenson-Yang, China is a gigantic country with different economies varying by regions. How is the Chinese economy doing in general?

Hard to tell. We have so much less transparency then we used to. We’re kind of back in the early 1980s when the quality of information was just really poor. There’s a big unemployment problem among migrant workers and in the service sector. In major cities, you see a lot of little shops and restaurants that are closed, and we know that perhaps 20% of migrants have not gone back to work. Considering that’s a population of about 280 million, 20% are a lot of people.

Why can’t they go back to work?

Because there are less jobs. Everybody is saying: «Wow, China’s back at 85% of its capacity». But where is everything going if people domestically as well as internationally aren’t buying? We know that export-oriented industries are down, and domestic investment and consumption are down, too. So low skilled labor does not have any place to go. That’s why you had Premier Li Keqiang give this speech suggesting that everybody should just have a stall and sell stuff on the street. I mean, how pathetic is that?

Except for the recent outbreak in Beijing, China seems to have handled the Covid-19 pandemic quite well over the past months. Why is internal demand still weak?

China is reviving more than the United States because it did a much more thorough job of eradicating the virus. In most cities, you can now move around freely, go into the office and things like that. But people have less money and are pretty risk averse. Not that many small businesses have enough cash flow to sustain themselves for three months. A lot of them are closed down and that’s a problem for employment. And, when employment drops then income drops.

What does this mean for the economic outlook for the rest of the year?

The government has failed to respond with heavy stimulus, and that’s something they have been widely criticized for. Apart from telling the banks not to collect on loans, there aren’t really any programs to help people. So it seems that you are going to see a lot of mortgage defaults. The government can recapitalize the banks and it can give them cash in order to delay collecting loans for three months. But you can’t do that forever. Also, not only is unemployment rising but underemployment as well because an awful lot of companies were asked to keep their staff, and those staff have seen salary cuts. I know a bunch of people who never had their work interrupted but they have significant salary cuts which makes them more risk averse. It’s a vicious cycle that’s very hard to get out of.

How does all this affect China’s bubbly housing market?

It’s inevitable that property values are going down. For example, is there a market for those apartments in Beijing and Shanghai that cost more than in New York and London? Who’s going to actually pay that price? A drop in property prices is probably the single most politically sensitive issue. That’s why the government has always been very quick to provide loans to real estate developers so that they don’t have to drop prices to drive cashflow. Presumably, that’s still going on because you haven’t seen a lot of price drops. But what happens is you get these developments where prices just hover, empty inventory stays on the market, nobody moves in and they become sort of ghost developments. It’s an unfortunate use of resources, but if the government doesn’t continue to fund those developments the results are price drops and bankruptcies, and that’s politically very unfavorable.

What are the chances that China’s housing bubble will burst?

I’ve always thought that the means by which the bubble will burst is by a significant depreciation of the currency. Because what happens is you have more and more assets and flat US Dollar holdings. So relatively to the Dollar the Renminbi's value is declining. But because people can’t freely buy Dollars and assets overseas, they just keep on holding Renminbi and pretend that the exchange rate is 7:1. Many things are actually much more expensive in China because of the misvalue of the Renminbi. One time, I was trying to buy a belt, and I just gave up because I didn’t want to spend the equivalent of $75 on exactly the same item I can get at Target for $15. Eventually, these tensions get so extreme that people find ways to get their money out. And then, you have to have a currency adjustment, and that kind of sends a shock wave of deflation out in the rest of the world.

The Renminbi’s’ exchange rate to the Dollar has risen slightly over the level of 7:1. How long will the People’s Bank of China be able to keep the currency from depreciating further?

They have a lot of ability to toggle by selling a few Dollars and by closing up avenues by which people can get their Renminbi out. There is a whole lot of tinkering that the People’s Bank can do around the edges because maintaining that ostensible value of the Renminbi is extremely important to them for all sorts of reasons, largely political. But the question is how long can that last, and that question I have never been able to answer.

From the outside, it appears that the coronavirus has strengthened President Xi Jinping’s grasp on power. How stable is the political situation in China?

In terms of public health, China clearly handled the Covid-19 outbreak very well. However, the severity of the lockdown has had to have a very significant economic impact and we’re not really seeing it in the reports of Chinese companies. You feel like they are getting along on the fact that nobody can travel there and get information. Politically, Xi has focused a lot on closing down the channels through which the bureaucracy can organize. There’s scattered unrest all the time across China, but it doesn’t have a bridging movement or coherent ideology to it. For many years, local governments were seizing land from peasants and didn’t give them adequate compensation for losing their livelihoods. So if there weren’t mass protests then, why would there be now?

Trade tensions between the US and China seem to have eased somewhat. Do you think President Trump will get back to a tougher stand against China when we get closer to the election?

I don’t think you can ascribe any particular logic to the way Trump works. There is no logic except money, and China has provided a lot of money to Trump and to his empire. That’s what’s driving a lot of things. More interesting is China’s reaction to Trump. For a long time, they had a general support for him, mainly because they thought that he would undermine the US government and the US system, and that he would sort of back off the trade issues. Certainly, over the last six months, there is just a feeling that it has become too much. China can’t take it anymore. And, maybe there is a feeling that Trump is going to lose, so they try to put eggs in a different basket. I’m not really sure, but the tone of the Chinese government has changed a lot towards Trump.

What do you think the future of Hong Kong and Taiwan will look like against this backdrop? Is China’s recent move to rein in Hong Kong the start to a forceful takeover?

It’s very sad about Hong Kong because it’s so small and vulnerable, and the same really is true of Taiwan. I wouldn’t be surprised if the mainland government had figured: «Well, we’ve only got six months left of Trump and we know he won’t do anything, so why don’t we move now.» Xi clearly has very poor political instincts, at least internationally. So I wouldn’t be surprised if it all had to do with Trump and the end of the Trump days in the United States.

A focal point in the trade war is the tech sector. What do you make of China’s strategic effort to build out a cutting-edge semiconductor industry?

That’s a story I get really bored with. The Chinese national chip program has been going on since the early 1960s and they spend massive amounts of money on it. The reason why it doesn’t catch up are short-term bureaucratic targets. The Chinese science ministry – until it got embarrassed by doing so – used to just post an online list of international technologies that Chinese companies would be awarded for replicating. So you had all these companies replicating western technologies. But their products don’t perform quite as well and they’re already out of date by the time they hit the market. It doesn't work, and yet they keep doing it. Another feature of the Chinese tech push is always vertical integration to capture more profit within a certain industry – or at least that’s the idea. They build endlessly redundant PCB factories, chip manufacturing plants and so forth and end up with massively redundant capacity.

So you don’t think China will be able to create a world class chip foundry like Taiwan Semiconductor Manufacturing, Intel or Samsung?

That’s not what the Chinese economy does, and it’s not what the Chinese economy is going to do either.

Then again, in the case of Huawei China managed to create a global champion for telecom equipment and handsets.

You can see Huawei’s importance for China by the fact that they have imprisoned two poor Canadian guys for a year and a half now for basically nothing but petulance and revenge. There’s always this debate if Huawei is government controlled. I mean, what other companies get people imprisoned because they feel that their vice president is being mistreated? Huawei has a very special political place, and one has to be cautious about how to use its products. In some ways, it’s a sopped-up version of the whole Chinese tech economy: It’s been enabled and funded to capture all but the very premium level of technology from international companies and to commoditize and sell it. But if Huawei’s products were as expensive as their competitors’ then customers wouldn’t choose them.

If tensions between Washington and Beijing keep rising, what would that mean for firms like Starbucks or Apple which earn a significant part of their revenue in China?

International corporations are making less money, and they’re more negative on the Chinese environment than five years ago. I don’t follow Apple specifically, but that thing has already been happening for quite a while. At every level, the Chinese government has done everything it can in order to promote phones from domestic manufacturers like Huawei, ZTE or Oppo over iPhones. This has worked to some extent. So I don’t know what Apple’s calculus is about staying in the Chinese market, but the days of high growth are over.

At the same time, there seems to be a push to tighten regulations on Chinese companies that are listed on US stock exchanges. What’s your take on these efforts?

There has been quite a bit of legislation that has been proposed, but none of it has particularly strong teeth. That’s because the opposition to strong regulation comes from the same people who have been benefiting from them Chinese listings like the big US banks and the political candidates they support. That’s why it would be easier to get through legislation that opposes for example Chinese listings in the US that don’t allow US auditors to operate in China.

What’s your advice when it comes to US listed companies from China? How careful do you have to be as an investor to not get conned by fraudulent accounting practices?

With Chinese companies it’s always the same: Just stick out a hand and you will find fraud. But I would be a terrible person to give investment advice to anyone. I’m the one who sold my house in Beijing in 2011. That’s how convinced I was that the market was going to drop in 2012. Yes, the market dropped a little, but then it came right back. I would have made double the money if I would have waited until 2018. So don’t take my advice.

Yet, J Capital’s call to short Luckin Coffee was spot-on. In general, your firm has an excellent reputation when it comes to uncovering scams.

In the case of Luckin, I’ve been surprised by the involvement of several levels of Chinese authorities. In the past, they haven’t had that jurisdiction and didn’t want to have anything to do with these companies. You can understand why: International markets are essentially a big ladle of gold for Chinese companies. You just get there and suck up capital. And, fraud goes without any sort of punishment at all. So if you’re the manager of a Chinese company, why wouldn’t you create fraudulent accounts? There is no downside and lots of upside. That’s why there is a lot of competition in China to list on markets. So what happens is that the market selects for those people who are good at fraud, presenting themselves as tremendously confident. Elon Musk types essentially: Pitchmen for their companies.

Luckin coffee isn’t the only Chinese company that has been unmasked as a fraud recently. Will it get more difficult for Chinese firms to get money from western investors?

Hard to know whether that will stick and affect other companies. Certainly, the market's confidence in Chinese companies has declined. Also, timing is important. Look what recently happened with two Chinese finance companies: Wins is being delisted by Nasdaq, yet the stock went up by 800% intraday and closed up by 100% or so. A similar thing happened with Jiayin, another one of those weird P2P companies whose stock rose 300 or 400% intraday. Who wants to take a risk on that market?

And what’s your take on Chinese internet giants like Alibaba, Tencent or Baidu?

I’m waiting for the day that Alibaba or Tencent default on their debt or decide that they are going to delist. Then, American investors all sort of realize that the whole Chinese concern is very much fraud and problematic. Alibaba and Tencent are the two biggest private banks in China. That’s principally what they do: They aggregate and deploy capital. It’s essentially pyramid schemes. Right now, the idea is: «Well, there are some companies that are fraudulent, but then there is Alibaba and Tencent.» That’s not true, but these companies have had rising share prices for many years now. So people made money off of them and pay no attention.

What do you make out of Jack Ma’s retirement from Alibaba?

I don’t know, but if anybody can guess which direction the Chinese economy is going, then I would certainly trust Jack Ma more than I trust myself. If he decides it’s the right time to step down, then everybody else ought to take notice. He probably must think that the happy and fat days are over. But there could be other reasons. His retirement could mean that he’s just tired of having everybody with their hand in his pocket. He has a very high political profile; he blogs a lot and talks about political ideas. It may be that he was asked to step down. I have no idea.

Is there even a good Chinese company which is worth an investment?

There are plenty of good companies in China, but whether things are worth investing in depends all on the price. The problem with investing in China in general is that people are investing in an idea about growth that actually is not true. The companies know that. So they all have to show growth, and the way they show growth is really lame and obvious: I will collect money and I will invest the money in my own growth, so then I show growth. A lot of these scams are super obvious. With Luckin, you could tell by being a customer that it was fraudulent. But people were not willing to believe that because they wanted to invest in the Chinese consumer. Alibaba, in my view, is just as obvious a fraud. But people are like: «Everyone buys online, so it must be a great company!»

Anne Stevenson-Yang

Anne Stevenson-Yang is a co-founder of J Capital Research and is J Capital's Research Director. The esteemed firm publishes highly diligenced research reports on publicly traded companies, relying on deep, on-the-ground primary research. Founded late 2010 in China, the company has particular expertise in the Chinese market but looks at overvalued companies throughout the world. Anne 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, Anne 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.
Anne Stevenson-Yang is a co-founder of J Capital Research and is J Capital's Research Director. The esteemed firm publishes highly diligenced research reports on publicly traded companies, relying on deep, on-the-ground primary research. Founded late 2010 in China, the company has particular expertise in the Chinese market but looks at overvalued companies throughout the world. Anne 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, Anne 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.