Is There Method In China’s Madness?

Date: 09/20/2021
Author: Mr. X

On Monday, the Dow lost more than 614 points and the NASDAQ more than 330. September is historically a tough time for the markets and there were any number of reasons a correction finally hit. These include rising natural gas prices in Europe, the stubborn persistence of the COVID-19 pandemic (now officially worse than the 1918 Spanish Flu), and questions about whether Congress can pass an infrastructure bill. Congress is also feuding about raising the debt limit.

However, one factor may have been more important than any other. This is the situation in China.

It has two aspects. First, the Chinese government may begin subduing billionaires and real estate tycoons in Hong Kong the same way it has in mainland China. Business leaders like Jack Ma have been reminded that “socialism with Chinese characteristics” isn’t just talk. President Xi Jinping’s “common prosperity” program may be tough to implement. Yet if you’re an ambitious leader, you can always ensure popular support by portraying yourself as a champion of the common people against the wealthy. We’re seeing a fascinating example of how that works in an authoritarian regime.

The second and far more important factor is China Evergrande Group. On Thursday, the company faces a payment on its offshore bonds, one it is going to be unable to make. The Chinese government faces the same kinds of questions America’s government did in the 2007-2008 financial crisis. This could be China’s Lehman Brothers.

As Dr. Kent Moors warned all the way back in February, the Chinese government has created a “shadow” economy. “Production and urban facilities continue to be built not to service genuine need or expected levels of market demand but to absorb increasing levels of debt,” he wrote.

Now, it appears, those debts are coming due.

This won’t just be a “Chinese” problem. Ashmore Group Plc, UBS Group AG, HSBC Holdings Plc, and the mighty BlackRock Inc. are reportedly among the bondholders.

The obvious response would be a restructuring of China Evergrande and possibly folding some assets into state-owned enterprises. However, the Global Times, which is backed by the Chinese government, recently said that the company should not expect a bailout. Evergrande is not “too big to fail.”

Tough talk. We’ll see if the Chinese government sticks to this line as economic pressure increases, but it’s not unreasonable to think it will.

President Xi Jinping’s “shared prosperity” program doesn’t correspond with bailing out private companies. The events of the last few months are proof enough that the Chinese government is not afraid of taking on Chinese tycoons. If China lets Evergrande fall, the world is looking at a global economic problem. Many of these governments have already stretched debt to the breaking point.

Is there any reason to think the Chinese will allow this to happen? The old saying about the Chinese character for “danger” and “opportunity” being the same thing isn’t really true, but an atmosphere of crisis does pose some genuine opportunities for China – at least to those in charge. China also wouldn’t necessarily be acting alone.

Russia has its own revanchist tendencies under Vladimir Putin. President Putin also seems to feel secure, having just won a (disputed) political victory in recent elections, broken Belarus to his will by helping Alexander Lukashenko retain power, and starving Europe of natural gas. The cagey ex-spy almost certainly won’t dare action against a NATO state. Yet if he can secure grudging acceptance of Russia’s acquisition of Crimea and a restart towards the Union State with Belarus, he’ll have played his hand brilliantly. In any event, he knows that he has a strong ally in China if he keeps supplying it with energy.

China may dare far more than Russia. China may also think it has a far stronger hand (and America a far weaker one) than is the case. This may sound alarmist. However, consider recent events;

  • American Secretary of State Antony Blinken deleted a tweet saying that the United States stood with the people of Hong Kong.
  • China has essentially “grounded” national youth by imposing restrictions on video games – and, significantly, justified this on nationalist grounds by comparing gaming to “opium” peddled by the West.
  • The Chinese government has increased control over pop culture, notably pursuing a ban on “effeminate” men in the media and greatly reducing several celebrities’ presence on the Internet.
  • The American withdrawal from Afghanistan, the Taliban’s declaration that China is its top ally, and the strong relationship between Pakistan and China make it more difficult for China’s rivals to stir up dissent among Chinese Muslims in the western provinces.
  • The “AUKUS” pact between Australia, the United Kingdom, and the United States has backfired. France reacted with fury after Australia canceled a deal to buy French nuclear submarines in favor of American ones. Australian Prime Minister Scott Morrison is also declining in the polls right now.
  • Russia just held the largest wargames in Europe in 40 years.
  • Nineteen Chinese military jets entered Taiwan’s military airspace earlier this month.
  • The first major military drills by Japan in 30 years led to accusations by China that it was “preparing for war.”

Moves by the Chinese government to tame corporate leaders, companies, and even celebrities suggest that the government saw this economic crisis coming. It’s one of the oldest political tricks in the book to preserve legitimacy during a crisis by rallying the people against foreign enemies. That may be how Beijing is planning to handle upcoming economic turmoil.

China may just want to posture, yet such maneuvers can spiral out of control. Even a largely symbolic action like claiming a small disputed island would necessitate an American response, especially since American credibility is so low following the Afghanistan defeat. That “defeat” was more of a strategic withdrawal by the Biden Administration to focus on China. Unfortunately, like AUKUS, it could have had the opposite effect from what was intended. Now, China may think President Biden is weak and won’t do anything to check Chinese ambitions.

Is there a sign that investors can look for to predict what’s coming? Nothing is certain in geopolitics, especially when it comes to predicting the actions of Beijing.

That said, whether the Chinese government restructures or bails out Evergrande Group will be of major importance. If the Chinese government simply lets it go under, I’d prepare for major turmoil. In my opinion, it would be a sign that China is preparing a daring geopolitical move and may even welcome a certain degree of economic turmoil as a backdrop. 

One thing is for sure. The American establishment has been waiting decades for capitalist economics to translate into democratic government. It’s going to have to wait a lot longer.

For many years, the Chinese government has maintained its legitimacy by delivering economic growth. If that calculation changes, and Chinese elites are forced to choose between maintaining their power or doing what’s best for global markets, I have no doubt China’s leaders will put their own interests first.

Mr. X is an investment analyst working in the Washington DC area who specializes in the intersection of business and public policy. After fifteen years working in politics, he writes on a classified basis for three times a week to bring you news on what those with power are debating, planning, and doing.

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