It is consensus now that China’s economy is slowing (or on “shaky ground” as one op-ed writer in The Guardian puts it). It’s also a prominent view today that its economic data cannot be trusted. But when it comes to protecting investors from these risks, three witnesses from the think tank and asset management world urged caution.
In a hearing titled “China’s Current Economy: Implications for Investors and Supply Chains”, the U.S. China Economic and Security Review Commission asked panelists to describe the recent China debt crisis to the U.S. economy. Real estate developer Evergrande Group filed for bankruptcy in New York last week. They owe bond investors $28.1 billion. This topic never came up at the hearing.
In dollar terms, there is around $11 trillion in overall China government and corporate debt that needs to be restructured in the best-case scenario, said Logan Wright, a China analyst for the Rhodium Group. [Testimony]
“The banks that are most likely to be exposed to the debt risks are China’s big city banks,” Wright says, never alluding to any financial risk for American firms, or systemic risk to big investors here. He said it was unclear who owned the shorter-term debt, but that it was likely all domestic. “Someone in Beijing needs to decide who will be exposed to market risk, and what is too much market risk so it does not lead to a financial crisis,” Wright said. “That’s difficult.”
Commissioners did not seem impressed, or all that worried about how hard it will be for China to cover its debt woes. One takeaway from the hearing was that some commissioners thought now would be a good time to get some concessions from China, though none were mentioned.
Commissioner Randall Schriver asked “What if we want to put Xi Jinping under tremendous pressure now? What are the things we can do to kick them while they’re down, if you will?”
Witnesses opposed applying pressure, saying that China was its own worst enemy.
“I would advocate against that approach. You’d need an agreement on that with allies,” Wright said.
Nicholas Borst, Vice President and Director of China Research for Seafarer Capital Partners [Testimony] agreed. “If you wanted to increase economic pressure, further decoupling would put pressure on China but it will cost U.S. companies and investors,” Borst said. “An angry and isolated China will be worse for us in the long run. China is too big, too interconnected, too dynamic to be isolated like the U.S. has done against other countries.”
Zongyuan Zoe Liu, a fellow at the Council on Foreign Relations, warned that if Washington put greater economic pressure on China, it would exacerbate the ongoing migrant crisis. [Testimony] This take was a surprise.
“If you worsen the Chinese economy, you will have an immigration problem. Look at the Chinese immigrants now coming in from Mexico. It has more than doubled,” she said.
Commissioner Michael Wessel said that he keeps being warned not to push China too hard too fast. “We need to worry less about how the CCP is going to respond, I think,” Wessel said.
Commissioner Jacob Helberg tried to get Borst, an asset manager, to say whether the headlines about bankruptcies and no longer sharing certain economic data points made China uninvestable. Helberg, appointed in 2022 to the Commission, asked if federal employees should derisk from China in their retirement funds.
“Don’t China companies have a long history of misrepresenting their business to American investors?” he asked Borst, who holds China investments for his clients and himself. His response was a window into how Wall Street thinks about China’s financial risk and opportunity.
“We invest in a lot of difficult markets around the world. We are skeptical from the beginning,” he said, adding that they do their due diligence on companies.
“Sure, but should the American government allow for investments in China in their pension funds, whereas investors are not going through the due diligence you go through,” Helberg asked.
Borst put the onus on the funds themselves to explain the risk to those who buy into their product – be it a mutual fund or an exchange-traded fund. He said all funds do this already, but Helberg did not push back that these large funds tha invest in hundreds of stocks and bonds from around the world in one single product are mainly trusting what they are told from China, if they are told anything at all. Moreover, for some companies in China, third-party financial audits, for instance, are not even allowed. But Helberg did not address this point, he only concluded by saying it was “high time American pension funds are not in the gambling business in China.”
Had Helberg mentioned companies by name that have folded and misrepresented their financials, or were forced to delist from the U.S. by the CCP, Borst might have responded how he was hurt by those investments, or successfully avoided them. Helberg never mentioned the Public Company Accounting Oversight Board’s years-long attempt to get Chinese companies to allow for third-party audits of its financials, and how many of those companies that ignore those listing requirements by the Securities and Exchange Commission may be in mutual funds invested in by American generals and Air Force captains, let alone rank and file employees of the federal government.
Is China’s Economy ‘Collapsing’?
Borst said he doesn’t think the Chinese economy is collapsing.
“Even with the economic slowdown, China will be about a third of total global growth and the U.S. will have significant business interests there,” he told the Commission.
When asked what the U.S. could do to increasingly de-risk from China, no one on the commission mentioned reshoring or the latest laws which provided tax incentives for the reshoring of semiconductors and solar goods, for example.
Liu said that going after China on trade while it is in a slowdown “will be bad for the U.S. and for U.S. companies in the long term.” She did not mention tariffs.
Alex Wong, vice chairman of the Commission and a senior fellow at The Hudson Institute at Stanford University asked about supply chain diversification and trade diversification. This opened the door for more talk about de-risking from China.
President Joe Biden said during the May 2023 G-7 summit that de-risking involves “protecting a narrow set of advanced technologies critical for our national security” — with the greatest focus on “technology that could tilt the military balance.” The Commerce Department has explicitly embraced “national security” export controls on China regarding technologies that “improve the speed and accuracy of its military decision making, planning, and logistics.” This affects U.S. computer hardware exports primarily, including those that have civilian uses.
With a focus on blocking China’s access to some computer hardware, and only allowing for the CHIPS Act and the Inflation Reduction Act (IRA) to speak to the derisking aspects of niche sectors of the economy, the three witnesses all agreed that if the U.S. was going to buy less from China, it should look to Mexico and Asia. Besides those two incentive programs — CHIPS and IRA — the U.S. was not mentioned in this panel.
Wright from the Rhodium Group even talked about opening markets and reducing trade barriers, even though the U.S. has the lowest trade barriers in the G7.
“What we need to do, if you want to have manufacturing alternatives to China, is reduce trade barriers in Asia in particular,” Wright said. This is largely out of Washington’s hands. It is unlikely India is going to lower tariffs to import American manufactured goods or agricultural products they grow at home, and could expand upon. Still, Wright thinks that is the way to go, saying, “If you are thinking about decoupling, you need to think of that as the next step.”