21 September 2021

No Arminius Capital fund has any direct exposure to Chinese equities. This is a deliberate policy: we can read the Chinese-language financial accounts of Chinese companies, so we know that these contain some of the most imaginative fiction outside the bestseller lists. But we want our investors to understand what is currently happening in the world’s second-largest economy, so this is the first in a series of articles on the recent events in China.

 

China’s crackdown on its homegrown tech giants has triggered waves of confusion in the West. Some political commentators have criticized the Chinese government for undermining individual liberty, rewriting the social contract, and asserting the supremacy of Communist ideology in business and private life. Some financial commentators have claimed that Xi Jinping is destroying private enterprise and making China “uninvestable”.

Have these people forgotten that China is run by the Communist Party? Ever since it kicked out Chiang Kai-shek’s Nationalists in 1949, the Party has always asserted total control over everything in China. (Not to mention a lot of things outside China.) In October 2017 the 19th Party Congress repeated the words which Mao Zedong spoke in 1962: “In politics and in the military, in society and in education, in the north or the south or the east or the west, the Party is the leader of everything.”

The Party has 92 million members and they occupy all the positions of power in government. Businessmen often join the Party when young, and prudent businessmen always make sure that they have friends and patrons in the Party’s hierarchy, not just by means of bribery, but also by longer-term methods such as shared ownership or employing the relatives of the elite.

The Party does not care about Western values or the approval of Westerners. It has always had its own well-developed system of patriotic Marxist values. Its theories of dialectical materialism and scientific socialism tell it that history is on its side. This is why history is important to the Party, because history proves why the Party’s actions are always right, and history shows that the Party is leading the Chinese nation on the true path to the future. The Party does learn from history: the collapse of the USSR in 1990 prompted the Party to carefully analyse what had gone wrong there and to make sure the same thing didn’t happen in China.

If you understand the Party’s history, you can understand what the Party is doing. What is happening in 2021 is a “rectification campaign” (zhengfeng yundong), which is what the Party does whenever the leadership decides that “bad elements” of the Party or of Chinese society are misbehaving and need to be corrected. Xi Jinping led off his rule in 2012 by announcing “the great renewal of the Chinese nation”, and his first rectification campaign was a nationwide anti-corruption crackdown, which proved very popular with ordinary people because it hunted down corrupt officials and punished them severely.

The current campaign will not lead to a re-run of the Cultural Revolution. China is now too large and too complex for the leadership to organize another Cultural Revolution. The original 1966-1976 version was Mao’s last throw of the dice to regain power, after the rest of the leadership had sidelined him in the wake of his catastrophic policy failures such as the Great Leap Forward.

Indeed, China’s economic czar Liu He has been at pains to emphasize that the Chinese government has not changed its support for the private economy and will not do so in future. Liu He pointed out that the private economy contributes more than 50% of tax revenue more than 60% of GDP, more than 70% of technological innovation, and more than 80% of urban employment. He stressed that China would continue to develop along the lines of a mixed economy – what Chinese planners call a “socialist market economy”.

Why is all this happening now? Because 2021 is the first year of the new Five Year Plan, which sets the top priorities for the Chinese economy. (We will explain these priorities later in the series.) Xi Jinping has revived the old Communist mantra of “common prosperity” (gongtong fuyu) and turned it into a set of principles to guide economic and social policy.

A central theme of “common prosperity” is consumer protection. This is the motivation behind the assault on the homegrown tech giants such as Alibaba and Tencent, who have abused and exploited consumers by misusing the personal data which consumers have given to their platforms. (Much more about this later!)

Another key theme is the reduction of inequality. The leadership is well aware that, over the last two decades, China has seen the emergence of huge disparities in income and wealth. In June 2020 Premier Li Keqiang noted that, out of China’s 1400 million people, 600 million people – 42% of the population – earned less than $200 (1,000 renminbi) per month. Three quarters of these 600 million live in rural areas, and about one third of them live in China’s less developed central and western provinces. (Source: Caixin 06 June 2020.)

The announcement that the government will “regulate excessively high incomes” is not about robbing the rich to give to the poor. It is about reducing tax evasion. China’s new rich have learned how to conceal income, how to re-arrange income across family members, and how to move assets to other jurisdictions. In the past, the central government did not have the skills or resources to pursue most of the miscreants, but – thanks to the experience and information gathered in the anti-corruption campaign – the tax collectors are much better equipped. The recent public shaming of some celebrities for tax evasion signals that this is now a top priority for the central government.

 

To be continued …

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