When Xi Jinping began his first term as the President of China in 2013, the country’s economy and markets were on the rise, and their future looked as bright as ever. In the years that followed, China’s economic progress was astounding, and the idea that China would soon overtake the U.S. as the greatest economic power was perceived in the West as an established fact. What supported this belief was also the meteoric rise in the Chinese stock market, with Chinese companies achieving huge market caps, which rivaled their U.S. counterparts, and Chinese equities gaining growing inclusion in the international stock indexes.
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The West: Close Your Nose and Invest
China’s economic growth and market surge were so dazzling that the West collectively ignored the encroaching authoritarianism of the Great Leader Xi, whose tenure at the helm of the Communist party was tainted by militant nationalism, a fast deterioration in human rights (including the semi-genocide of Uyghurs), mass surveillance and detentions, ever-rising censorship, and a cult of personality developing around Xi – a quite typical path to dictatorship.
The way China dealt with the COVID-19 epidemic, including such horrible incidents as welding people’s doors from outside to force total lockdowns, showed clearly what many in the West have already started to suspect: that China was becoming a totalitarian state – again.
Meanwhile, Xi Jinping, who was perceived as a free-market enthusiast at the beginning of his career as China’s leader, reversed his stance toward lessening the government’s involvement in the economy. His government installed Communist Party officials inside private firms, sometimes taking them over entirely to the hands of the state. The government officials held the credit tap handle, deciding how much credit and at what price should be given to the private sector by the state-controlled banks.
However, Chinese “state capitalism” has survived many hurdles, including a trade war with the U.S., and its growth rates continued to outperform free-market economies (if Chinese statistics were to be trusted). Thus, the country’s stock markets still beckoned to Western investors, attracting billions of dollars and euros that were bet on the continued rise of its highly successful corporations, such as Tencent (OTC:TCEHY), Alibaba (NYSE:BABA), ByteDance, and others.
The Enemies of The State from AliExpress
However, the suggestion that a country can be politically authoritarian while maintaining free capital markets got a shattering blow in 2020 when the Communist party issued a new set of rules for private companies, requiring them to serve the state. A few weeks later, Xi personally blocked what was expected to be the world’s largest IPO, Ant Group’s $37 billion offering. Prior to the IPO, Ant’s founder Jack Ma criticized the Communist party’s economic policies – and the reckoning was fast and furious.
Ant Group was just the beginning of a crackdown on China’s high-flying firms, as Xi increasingly viewed successful corporations as unreliable and untrustworthy rivals to his tightening grip on the country. In recent years, it looks like Xi has been on a mission to destroy all private economic initiatives, sector by sector.
Thus, in 2020, Beijing rolled out a policy aimed at preventing a burst of China’s real estate bubble – but the sudden pivot in government-ruled credit availability hastened the crash, leading to a wave of defaults including those of large developers such as Evergrande (OTC: EVGPF) and Kaisa (DE: KG5), as well as a crash in property prices. The Chinese real estate sector stands at about 30% of its GDP, posing a great risk to the economy, already reeling under Xi’s “zero-COVID” policy and the global slowdown.
Another state-induced crisis arrived in 2021, as Xi’s China continued to tighten its grip on the tech sector; the Chinese president’s attack on the “disorderly expansion of capital” clearly showed the path ahead. Actions followed the slogans, first with a torrent of regulatory blows and antitrust swings aimed at tech platforms like DiDi Global (OTC: DIDIY), Meituan (OTC: MPNGF), and Pinduoduo (NASDAQ: PDD), and then dealing a knockout to the Chinese education tech sector.
Online schools were the one place where the state was not controlling every aspect of the curriculum as they’d been doing with regular schools. The Communist party was clearly unhappy with that fact – so the authorities banned for-profit online education centered on public school and university curriculums. Once the darlings of Wall Street and venture capital, edtech firms like New Oriental Education and Technology Group (NYSE: EDU) and TAL Education Group (NYSE: TAL) were out of the business of teaching outside of the party-approved lines.
You Can’t Have Both Economy and Communism
Despite the fact that the communist crackdown on economic freedoms has been going on for a few years and clearly isn’t ending anytime soon, many Western investors have remained optimistic about Chinese stocks. Even the poor performance of Chinese stocks hasn’t discouraged the China optimists: with all the declines, S&P 500 (SPX) is up around 9.5% in the last two years; meanwhile, the Chinese Hang Seng index is down 35%. However, the ongoing sweeping change is expected to sink in now after the Chinese stock market bloodbath that followed last month’s 20th Communist party congress.
Xi Jinping’s speech and his choice of a new leadership team unveiled his tightening grip over the military and economic powers, clearly signaling a focus on security and state control rather than on business-friendly policies. Mr. Xi has cemented his one-man rule, consolidating his hold of all aspects of life in China – and the wording of his speech doesn’t bode well for the Chinese private sector and its investors. Obsessed with power and security, he is more focused on quashing all ideological and geopolitical challenges than on economic progress.
The agenda that is now expected to mark the way forward is “common prosperity” – reminiscent of all the communist slogans from the days long past that ended with no prosperity but with common suffering. Xi has signaled to move toward the concentration of the state’s role in the economy, which implies that the role of private companies will become muted.
The hopes of China-optimistic investors that China will successfully combine socially restrained capitalism with “reformed” communism were shattered at the Communist Party congress in October, where it was as much as stated that China will aim to dominate the world under the eternal rule of the Great Leader Xi.
Poetics aside, it should be clear now that China is tilting away from free markets and back toward ideologically driven centralized planning. So it is not surprising that the shares of Chinese companies listed in the U.S. fell on the day of the Congress, while Chinese shares traded in Hong Kong tumbled to their lowest level since 2008. Their investors suddenly understood that they could be saddled with regulatory restrictions or even delisted at any moment on the whim of the Politburo. Frustrated international investors pulled a record $2.5 billion from mainland China stocks on the day of the congress alone.
China is Uninvestable Again
Surrounded by his crew of loyalists, autocratic Xi will meet little to no resistance to his efforts to pivot the country’s focus away from economic growth toward redistribution and state control. As God only knows which sector will draw Politburo’s ire, leading to a sudden loss of value, Chinese stocks look uninvestable for any reasonable investor.
Of course, in the short run, all kinds of oddities are possible. However, as a rule of nature, in the long run, a free economy and free markets can not work without a free society. Communism – all its versions, from Stalinist to Xi-ist – doesn’t seem to work, neither politically nor economically. Having established that, investing in Chinese stocks now would be akin to betting against the casino: it may work until the house changes the rules.
