Market Overview

Market Overview

China Update, January 25, 2017

Author: John Hsu/Monday, February 6, 2017/

In the past we have stated that China is probably the most misunderstood economic system in the world. It is a blend of totalitarianism (quite a mouthful) and free enterprise. Dictatorship exits at the top but in commerce our version of free enterprise flourishes among the ordinary citizenry. Over the last few years many in the west had predicted numerous hard landings for the Chinese economy. Debt load, shadow banking, etc. usually get cited as the triggers. None have materialized.

At this stage, China is still by and large a domestically driven economy. The huge debt is incurred by the state owned enterprises (SOE). The banks that are the issuers are also state owned. Therefore the entity that ultimately owns the paper is the state which can and does upstream the bad debt and in exchange injects new and healthy assets back down to the operating companies. This can't go on forever but Beijing has plenty of assets left to take public!

This is one of the reasons as to why one can't look at China through western eyes.

Last year China embarked on a major reshuffling of its economy from export driven to more domestic consumption, an altogether major challenge especially since China is the second largest global economy. Bloomberg reported that as much as China's economic expansion slowed last year it added an entire Netherlands, the size of a medium G-20 economy to its GDP! Also they seem to have made significant progress in transforming from an early 20th century metal-bending to a 21st century electronic-driven service economy.

Urbanization now approaches 60%.

All of this presents challenges for President Trump. At the start his knowledge is dated. The data he cites is at least three years old. We are way past the point of threatening or staring them down.

As for the South China Sea and the man-made islands, just as with the Russians in Syria, the Chinese are now solidly established there, barring going to war, what can we do about it? Obama blinked and created the opportunities and they seized upon them! Domestically in China, supply seems finally to be in better alignment with demand. Those in the manufacturing sector in China tell us that there has been a dramatic pickup for their business.

Perhaps just as important is that China is due for a leadership reshuffle later this year (the leadership serves two terms of five years). Xi, the President will likely keep everything in shipshape before he goes to his Party Congress. By the same token Trump's advisors should tell him that Xi does not have much room for negotiation given the timing.

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