Kissing the Ring, or, The First Rule of Power
When investing in China, investors will do well to keep in mind the First Rule of Power
The First rule of Power is that Power is Power. Corollary to the First Rule of Power is that only Power is Power; to mistake anything that is not Power for Power itself is to commit a Cardinal Error, a category mistake.
Power is the ability to enforce one's will, to have one's way. Pursuant to the First Rule is that it is always a Cardinal Error to mistake Money for Power. Money is subsidiary to Power. It is often a complement, but never a substitute. Ask the common person if they have ever heard of Julius Caesar, and they will likely respond in the affirmative; ask them who Marcus Crassus was, and you will receive only a blank stare.
This is important for the following reason: too often in the liberal, capitalist west we analyze investment from a predominantly economic perspective. It was the great insight of the inventors of economics to refer to their new discipline not solely as Economics, but as Political Economy. This is the result of the triumph of the Physiocrats over the Mercantilists, but also their synthesis. When we look at the world's economies of the 1930's, or those of the 2010's through the frame of political economy, we are unsurprised by the rise of Fascism and Populism then or now. Brexit is foreseeable; the election of Donald Trump inevitable.
Others have written that investing in China-domiciled companies is both wise and proper. We won't refute the financial reasoning here. Viewed solely from this perspective, an investment is likely self-evidently profitable. China's economy still maintains a sizable advantage in cost of labor. Its productivity growth is the envy of the plague-stricken developing world. Its socialism with Chinese characteristics--or, as we know it, state-sponsored Capitalism--has produced a tremendous increase in wealth for many Chinese. This is perhaps unsurprising. As John Kenneth Galbraith, one of goodstead's intellectual heroes, said: "Under capitalism, man exploits man. Under communism, it's just the opposite."
The rise of China is many things, but it is not inevitable. This is not to lay grass over Thucydides' Trap. China's economic success depends upon ever greater integration with the world economy, and continued demand from the world's markets. It must be successful in order to stave off demographic collapse brought upon itself by its own one-child policy. It therefore brooks no resistance to its growth. For this reason it poisons its rivers, pollutes its air, deforests its land and despoils its seas. It pulverizes its workers into a fine dust of technology magic for the markets of the world to consume.
It does this because the Chinese Communist Party which controls it cannot possibly survive a popular uprising driven by widespread want. It therefore suffers no challenge to its power. And so it commits atrocities on an extraordinary scale, from its ethnic cleansing of Nepal in the last century, to its building of concentration camps in Xinjiang; its massacre of democracy protestors in Tiananmen Square in 1989; its subjugation of democracy protestors in Hong Kong in 2019. The soft tyranny of its total surveillance state acts as a mental tax on its entire population, succeeding in the production of a more docile citizenry, but failing in the cultivation of a creative society. Industrial espionage has been its remedy for this failure of imagination, but the disease lingers.
China needs the rest of the world, but it doesn't want the world on terms other than its own. The more it integrates, the greater the threat to its own power it hazards. When the world trades with China, it exchanges a little bit of its values, a little bit of its principles--a little bit of its soul--for cheaper finished goods. While this Faustian bargain is an acceptable price for the Machiavellian set, it should be unacceptable for the ethical one.
The world can and should reset the terms of engagement with the Chinese economy. It holds leverage over China. It doesn't have to buy from China. Removing so much cheap labor from the global production function will result in higher prices for finished goods, but it will also ensure that the value of human rights, environmental stewardship and the dignity of labor are properly priced. The only winning strategy is not to play.
And so we come to the purpose of this polemic: Ant Group, a spinout of Chinese ecommerce group Alibaba, was supposed to conduct its initial public offering of stock to the investing public on Thursday of this week. At $37 billion, it would have been the largest IPO in history. On Monday, Jack Ma, China's richest man, was unexpectedly called before the People's Bank of China and financial regulators for undisclosed reasons. According to the Financial Times:
"...Mr Ma, Ant’s founder, had been called in for “supervisory interviews” and said there had been “other major issues”, including changes in “the financial technology regulatory environment." ... "The meeting came after Mr Ma criticised China’s state-owned banks at a financial summit in Shanghai at the end of October. Mr Ma suggested the big banks had a “pawnshop mentality” and that Ant was playing an important role in extending credit to innovative but collateral-poor companies and individuals."
To stop an IPO, especially the largest in history, at the last minute is highly irregular, especially in a country eager to be seen as leading the way out of the global pandemic and its economic contraction. The reported "other major issues" would presumably have been discussed and addressed over the summer, as the Chinese authorities have had months to review the proposed issue. There is certainly something to be said for consumer protection and managing systematic risk; in this case, the amount of credit Ant would provide to the market, and the number of creditors to whom it would lend, certainly don't represent a systematic risk compared to the size of state-owned banks' balance sheets. Rather, it is likely that Mr. Ma committed a Cardinal Error in his criticism of the People's Bank of China.
Investors in China should bear in mind that China's is a government of men, not of laws. Caveat emptor: assets invested there are forfeit if the powers that be think it expedient. Perhaps part of the reason why global portfolios only hold 3% of portfolio value in Chinese stocks and bonds rather than the 15% suggested by their share of global economic activity is because investors think there's an 80% chance of expropriation, but perhaps it's just because their souls are more dearly bought.