Milestones To Pragmatism
Sinology looks at the key milestones which should enable investors to anticipate a return to pragmatism.
The Chinese economy is weak primarily because fear of COVID lockdowns makes households and companies afraid to spend. I’m optimistic long term, however, because I expect Beijing to take a more pragmatic approach towards COVID after the winter flu season. At the upcoming Party Congress, Xi Jinping may not provide a clear roadmap for an end to lockdowns, but we can look for two milestones which should enable investors to anticipate a return to pragmatism well in advance of an economic recovery and a rebound in sentiment. These milestones are changes in COVID rhetoric and increases in jabs.
The Party needs to be pragmatic
Over the last couple of decades, China has become rich and the Communist Party has stayed in power because of pragmatic economic and social policies. A return to pragmatism—on regulatory and COVID policies—is likely in the coming quarters, which should lead to an economic recovery.
First, I will explain what I’m not very worried about.
I’m not very worried about China’s property market. It’s not a bubble. Bubbles are all about leverage, and homeowner leverage is much lower in China than in the U.S. In China the minimum cash down payment for a new flat is 20% of the purchase price, and the average is 30% down. Far from the median cash down payment of 2% ahead of the U.S. housing crisis. And, surveys tell us that about 90% of new homes in China are sold to owner-occupiers. With average new home prices up 33% over five years and 80% over 10 years, prices are not signaling the existence of ghost cities.
I’m not very worried about regulatory policy. Beijing made a lot of mistakes over the last couple of years, especially in the tech sector, but they’ve acknowledged this and have promised to be less disruptive. Why do I believe them? Because entrepreneurial, privately owned companies drive creation of jobs, innovation and wealth in China. The government depends on these companies. And I think the government’s "common prosperity" policy objectives are admirable: they are focused on the same inequality problems we are wrestling with.
I’m not very worried about demographics. China’s population is aging, but it’s a long-term issue: China won’t be as old as Japan is today until 2050. And, Beijing is taking steps to mitigate a declining workforce. A better educated population, for example, to help manufacturing move up the value chain. The number of university graduates rose 40% over the last 10 years. Additionally, government spending on health care has almost tripled over that time.
I’m not very worried about China invading Taiwan. The military risks are huge. Crossing 100 miles of sea would be far more difficult than Putin’s invasion of Ukraine. And the economic impact would be disastrous. China imports over 80% of the semiconductors it consumes, with about one-third—including all of the most sophisticated chips—coming from Taiwan. This supply would be cut off if there were signs that Beijing planned an attack, crippling China’s economy. There are no signs that China is preparing to use force.
So, what am I worried about? China’s zero-COVID policy.
Zero-COVID worked well prior to the arrival of Omicron. There were almost no deaths in China, and the economy was strong. Last year, consumer spending in China, the largest part of the economy, was up more compared to 2019 than in the U.S. and the Euro Area. Manufacturing was healthy and China held up its end of global supply chains.
After Omicron arrived, zero-COVID continued to be successful from a public health perspective. There have been no COIVD deaths in China since June, while the U.S. is now averaging over 400 COVID deaths per day.
But under Omicron, the economic and social cost has been significant. Fear of lockdowns has made families and companies reluctant to spend. Growth has slowed and unemployment has risen, especially among young people. Under zero-COVID, China’s economy is on an unsustainable path.
I’m confident, however, that the Chinese government will return to a more pragmatic approach, which strikes a better balance between public health and the economy.
I’m confident because pragmatism has made China rich and kept the Party in power over the last few decades.
So, when will Beijing return to pragmatism? Most likely in the spring, after the flu season, which may see a rise in COVID cases globally. I do not expect the end of widespread lockdowns during the winter, because that could overwhelm China’s relatively weak health care system, and lead to a spike in deaths, especially among the elderly, who have a low vaccination rate.
Between now and the spring, China’s economy is likely to remain weak. But, there are milestones we can look for in the coming months to anticipate a return to pragmatism and an economic recovery.
The 20th Party Congress begins on October 16. This meeting of the senior leadership takes place every five years, and is focused on personnel issues. Xi Jinping will be confirmed for a third, five-year term as head of the Party. Will he present a clear roadmap for a pragmatic, science-based approach to relaxing zero-COVID? Maybe not. These meetings usually don’t go deep into policy.
The new Party leadership—the Standing Committee of the Politburo— will convene at the end of the Congress, and they might announce a roadmap. That would generate a wave of positive sentiment, but we have to be realistic: Party leaders rarely issue clear policy roadmaps.
The absence of a roadmap would not, however, mean the Party is abandoning pragmatism. It would mean we have to look for specific steps that add up to a path to pragmatism.
I suggest focusing on two milestones: rhetoric and jabs.
The leadership may not give a speech which clearly lays the foundation for an end to lockdowns, but they will have to prepare Chinese people for living with COVID like the rest of the world. I will be watching for a gradual shift in official rhetoric away from a zero-tolerance for COVID cases and towards encouraging people to get vaccinated so they can live with the virus.
The second, most important milestone will be a rise in vaccination rates, especially for older Chinese. There are now about 25 million people (roughly the size of Australia) over the age of 60 who have not received any COVID vaccinations, as well as another 62 million (California plus Florida) older Chinese who have received only two shots, and who need a third for better protection. This is a very large number of people who would be at risk if COVID policy is relaxed prior to a major vaccination campaign. Moreover, in recent weeks, the pace of new vaccinations for the entire country has been declining. This must be reversed in order to prepare for ending lockdowns and living with COVID. Vaccination data is published weekly.
Closely following these milestones should enable us to anticipate a return to pragmatism well in advance of an economic recovery, and a rebound in sentiment.
Signs of pragmatism
Although zero-COVID lockdowns continue, there have been signs of pragmatism in Beijing. In August, China resolved a long-running dispute with the U.S. Public Company Accounting Oversight Board, and PACOB inspectors are now in Hong Kong, checking the accounting workbooks for Chinese companies listed in the U.S. This agreement goes beyond keeping 200 Chinese companies trading here. It signals a desire, in my view, on the part of Xi Jinping, to avoid economic decoupling with the U.S., and to steady his relationship with Joe Biden.
I believe U.S.-China relations will remain tense, but conflict, including over Taiwan, will be avoided. China’s economy is driven by domestic consumption, and active investment in Chinese companies selling goods and services to Chinese consumers mitigates the impact of political tensions.
A second pragmatic development came last month, when Xi made his first trip abroad since the start of the pandemic.
More recently, the government approved resumption of a marathon race in Beijing on November 6. This will bring tens of thousands of runners together in the capital—without masks, but with booster shots required—for the first time since the pandemic.
I’m anticipating a broader return to pragmatism in the coming months.
When that happens—only the timing is uncertain, in my view—keep three things in mind.
China is likely to remain the only major economy engaged in serious easing, while much of the world is tightening.
Chinese households have been in savings mode since the start of the pandemic, with family bank account balances up 39% from the beginning of 2020.
Those funds should fuel a consumer rebound, and an A-share recovery, as domestic investors hold about 95% of the that market.