China’s economy is coming in for a hard landing facilitated
by Covid-19 provoking a plunge in manufacturing and broken supply chains
Chinese leadership has broken the social contract through
crumbling credibility that has provoked open dissent and potential social
unrest
Now that the unthinkable has occurred, any subsequent event
emerging from this pandemic is plausible making an economic recovery
exceptionally difficult
One of these plausible events is the threat of leadership
change by restive political rivals in the shadows that represents a quantum
leap in business risk and volatility for the global economy
If someone in late October 2019 told you that a potent new
virus would emerge in China and spread so rapidly that the government would
physically lockdown a country of 1.4 billion inhabitants, you would claim it’s
a script from some upcoming dystopian sci-fi movie. Now that the unthinkable
has occurred, any subsequent event emerging from this pandemic is plausible
such as a leadership change in China.
China is an increasing risk for businesses and investors as
Covid-19 inexorably adversely impacts China’s economy by limiting a
manufacturing restart and strangling the supply chain to which the global
economy is highly dependent.
As the supply chains come under pressure to reestablish
themselves, so does the political food chain which Xi is the apex leader on
which he and his inner circle are becoming increasingly vulnerable to a palace
coup if China enters into a recession.
Crumbling Credibility
In an article in The NY Times article entitled
2019
Is A Sensitive Year for China, Xi is Nervous, on 25 February 2019 – just
over a year to the day - reported that President Xi openly warned of black
swans and gray rhinos. Well, the black swan has arrived in the form of Covid-19.
Because of Xi’s public relations mismanagement with ever changing,
hard-to-believe fairy tale narratives with respect to Covid-19’s progression, a
societal strain of anger has affected far more Chinese citizens than the virus
itself and has unleashed itself directly and openly through social media at
“the highest levels” - Xi himself. With the recent constitutional removal of
term limits Xi has made himself politically immortal making it almost impossible
to blame others.
With respect to cooperation and transparency with foreign
governments in this crisis, Xi followed the 2002-2003 SARS playbook in
combating Covid-19 instead of the one for the Manchurian Plague of 1910-1911
using 20
th century tactics to battle a 21
st century
crisis. In an eerie parallel the Manchurian Plague was a virus transmitted from
marmots [large squirrels] to humans. As articulated in The Diplomat,
What
History Teaches Us About the Coronavirus, 12 February 2020, the Qing
government appointed a Chinese doctor, Dr. Wuh Lien-teh to resolve the epidemic.
He and his colleagues collaborated and were transparent with
foreign governments (against the Qing policy but without punishment) and applied
quarantine and isolation methods, the wearing of masks by medical personnel and
the construction of a special care hospital. This relationship enabled them to
stop the epidemic and establish the foundation with foreign governments to
contain subsequent epidemics during the 1920s.
Breaking the Social Contract
Since his ascension to the presidency in 2012, Xi has
aggressively promoted the concept of a government as all knowing, all powerful while
demanding absolute and unquestioned loyalty and in return they’ll protect the
people.
For 30 years Chinese citizens have enjoyed a particular “way
of life” with minimal hardship in a growing and robust economy. In turn the
government’s sometimes heavy-handed surveillance policies & tactics and
human rights abuses against political undesirables are tolerated because
everyone was making money, a convenient capitalistic economic system within a
politically autocratic one.
The populist mask has fallen because Communism’s explicit
edict to protect the people has been exposed as a myth and underscored the
reality of “every man for himself”.
As articulated in The NY Times article 18 February 2020,
China
Blocks Alley in Virus Fight: Its Own People local grass-roots groups (civic
associations [business groups], nonprofit organizations, charities and
churches) have been discouraged by the government from organizing for the
purposes of assisting their local communities with medical assistance and
supplies that the government can’t fulfill.
The government’s failure to loosen social and political
constraints to combat the epidemic has ignited scathing anger. It’s a low
simmer but has the potential to boil over if certain ingredients are added.
China’s prolonged quarantine is turning into a societal pressure cooker as Xi
and the Communist Party have lost the meaning of genuine collectivity.
Open Dissent
Xi has openly worried about China collapsing like the Soviet
Union and has done much to prevent such an event. As quoted in the article
Party
Man: Xi Jinping’s Quest to Dominate China in Foreign Affairs magazine,
September/October 2019 issue, ““But Xi took his greatest warning from the fall
of the Soviet Union and was horrified at how the Soviet Communist Party had
evaporated almost overnight.”
Economic progress and rise in living standards can bring a
country just so far. A black swan like Covid-19 can rapidly wipe out those
gains and it falls upon government credibility with the citizenry to combat it.
According to the Wall Street Journal article published 4 March 2020,
China’s
Workers Suffer Layoffs, Slashed Pay and Shutdowns, as Coronavirus Batters
Businesses, Chinese businesses are suffering with layoffs and furloughing
of staff. The article states that China’s urban unemployment is now 5.2% up
from 4.8% in January 2018 to which many feel those statistics are understated
and that should the epidemic continue, a total loss of 5 million jobs is
possible.
The silent invisible elephant in the room is the growing
possibility of civil unrest, perhaps not the spectacular ones in Hong Kong throughout last summer and fall rather a low-simmer of defiance. Because of the
extreme nature of the crisis, this possibility is closer to reality than anyone
cares to admit. There have been increasing challenges by the public against law
enforcement article
Reports
of Society-Police Conflicts in China, as published in The National Bureau
of Asian Research, 25 November 2019, a growing trend before the coronavirus
outbreak.
It would not be too far-fetched to believe a “We are all Dr.
Li Wenliang” movement, the ophthalmologist, the hero, the martyr who reported
on the emergence of a deadly new virus and subsequently died from it on 7
February 2020. The nationwide outrage was palpable with seething comments on
open social media a place few Chinese dare post their genuine thoughts on
government policies.
Additionally the advanced surveillance technology gives Xi a
false sense of security because an invasive security apparatus tends to be reactive
rather than proactive. A leaderless groundswell of defiance and protests
perhaps taught by the “infiltrators” of the Hong Kong protests or those
mainlanders living in Hong Kong who witnessed and even marched alongside Hong
Kongers – far more than is acknowledged.
How does any government regardless of political practices
keep half or more of their population under lockdown and limited movement – 1.4
billion – without serious consequences? Just as importantly, how willing and prepared
is the Chinese government if social unrest should develop? The triggers is
often an innocuous event like the Arab spring when a Tunisian vegetable vendor
set himself on fire. What threshold will be crossed to trigger such an event?
The chart below shows China’s 11 megacities which are defined
as urban areas with a population of 10 million or more as provided by
China’s
Top Megacities, CNN Business Traveler, 5 March 2019. The Hong Kong protests
last year may be mere trailers of what could occur 11 times over in mainland
China.
|
Chinese Megacity |
Population |
| 1 |
Chongqing |
30,750,000 |
| 2 |
Shanghai |
24,180,000 |
| 3 |
Beijing |
21,710,000 |
| 4 |
Chengdu |
16,330,000 |
| 5 |
Harbin |
16,330,000 |
| 6 |
Guangzhou |
14,490,000 |
| 7 |
Tianjin |
15,570,000 |
| 8 |
Shenzhen |
11,900,000 |
| 9 |
Wuhan |
10,890,000 |
| 10 |
Shijiazhuang |
10,870,000 |
| 11 |
Suzhou |
10,680,000 |
|
|
|
| Total |
|
183,700,000 |
Restive Political Rivals
President Xi has many enemies hiding in the shadows notably
the wealthy families whose members during his anti-corruption campaign and
technocrats who have been politically marginalized. There are elements in
government who are both pro-China but are far more willing to work with Western
countries who seek greater integration, cooperation, collaboration and
transparency with strong sovereignty (aka normal engagement).
Historically autocracies always tighten their grip by
escalating violent tactics to control. Yet this very tactic accelerates chaos
and fracturing of the structure meant to control the citizenry. With respect to
Xi despite his efforts to maintain his lofty leadership position, he may be
that man who, as quoted by French poet Jean de la Fontaine, “meets his destiny
on the road that he took to avoid it.”
Should there be a successful change in leadership the
Communist Party will continue to rule China however as a different version, perhaps
like a Sino perestroika; somewhat more open and with less fear of punishment.
Economic Road to Recovery
China’s reign as the world’s manufacturing juggernaut will
be greatly diminished as firms will seek alternative supply sources. This trend
means less jobs and higher unemployment for Chinese workers as discussed
earlier in this article. This could provoke a recession for which central
bankers have limited tools.
The development and distribution of a vaccine can mitigate
such losses. But according to Dr. Irwin Redlener,
Professor of Health Policy and Management and
Pediatrics at the Columbia University Medical Center and Director of the
National Center for Disaster Preparedness at the Earth Institute, in the
29 February 2020 podcast entitled
Understanding
the Coronavirus sponsored by Columbia University, Center on Energy Policy,
a successful vaccine
will not be available for at least 18 months (minute 20-21 of the podcast).
Although not discussed in the podcast, I believe that if
there are mutation(s) then different vaccine(s) must be developed, manufactured
and delivered. Complicating matters is that each person receiving the vaccine
must be tested to ensure that the correct one is administered by already
over-worked and understaffed medical professionals.
Recommendation
The additional of potential political risk and uncertainty
in China has fueled the urgency for businesses to aggressively seek alternate supply
sources outside of China and/or sources that are not dependent on China. Business
will initially suffer greatly diminished production and sales but yet enough to
generate acceptable income. Because of the increased cost of supply diversification,
there’s the inevitable decision with respect to priority: price increases vs
market share.
For this reason investors should consider continued short
plays in specific sectors and/or a broad-based approach such as the China
economic & investment index (MSCI China Index).
Finally seek investment safety in precious metals such as
gold (iShares Gold Trust - IAU) and short-term US government securities such as
Federate US government securities (FSGIX).
Copyright Indo-Brazilian Associates LLC 2020.
Indo-Brazilian Associates LLC is a NYC-based think-tank and
advisory service that provides prescient beyond-the-horizon contrarian
perspectives and risk assessments on energy investments, geopolitical dynamics
and global urban security.
