What force will shape the world in the next 20 years? The answer is China's drive to financialise, according to Diana Choyleva, founder and chief economist at Enodo Economics.

In this episode of the podcast, Diana speaks to MoneyWeek's Cris Sholto Heaton about how the AI race differs in China versus the West, the transformation of the country's equity market, and the breakdown of globalisation.

You can watch this episode on our YouTube channel or subscribe to it on any podcast platform.

About the podcast

MoneyWeek Talks is a podcast that helps you unlock the secrets to financial success. Editors Kalpana Fitzpatrick and Andrew Van Sickle are joined by influential guests – from CEOs and entrepreneurs to economists and policymakers – to share their top tips on managing money, investing wisely and building wealth.

Subscribe to the MoneyWeek Talks podcast and get ready to make it, keep it and spend it with confidence.

Should you invest in China, or is it essentially “uninvestable”? That was the gist of the debate just a few years ago. The West can never quite seem to make its mind up about the Middle Kingdom. Once derided as cheap but tacky, in 2026 China is suddenly cool. Social-media influencers show off their indoor slippers and traditional Chinese medicine, while quipping that they are “learning to be Chinese”.

Polling by Pew Research shows that, while only 28% of Britons aged older than 50 have a favourable opinion of China, that figure doubles to 56% of the demographic aged 18-34. Where older Westerners see a repressive one-party state, the young scroll TikTok and share images of the futuristic “cyberpunk” city of Chongqing (it's worth a visit, if you can handle the brutal humidity).

A warning for those wanting to invest in China

This pendulum swing is nothing new. During the 2000s, China's extraordinary growth (14% in 2007 alone) led to feverish speculation about when exactly it would become the world's largest economy (2027, according to one widely cited projection). The story remained bullish during the early 2010s, as China used a massive infrastructure stimulus package to duck the stagnation plaguing developed economies after the great financial crisis. In the process, the country built the world's largest high-speed rail network, a service whose gleaming modernity makes Britain's trains feel like a donkey and cart by comparison.

But simultaneously, a more negative narrative took hold. The first signs of trouble came in summer 2015 after a parabolic run-up in Chinese shares went into reverse. The CSI 300 index plummeted 44% between June of that year and January 2016. A MoneyWeek cover at the time depicted a dragon roller-coaster hurtling downwards. In many countries, such a plunge would herald the beginning of a devastating recession. Not in China (GDP registered an official growth rate of 6.7% in 2016, a modest fall from the previous year).

In China, where the stock market is traditionally regarded as being little better than a casino, it is state banks, not investors, that decide where credit will be allocated. But it was a warning shot to investors. The most optimistic projections for Chinese growth didn't quite pan out. Today, total GDP is still only 65% of the US level, and a mere 15% of the level in terms of GDP per capita.

Still, grown it has, and at a rate and consistency with little precedent in world history. Yet those gains haven't accrued to those who decided to invest in China. Since the start of 2008, Chinese GDP has risen by 344%. The CSI 300? 1%. You can still make money if you invest in China, of course. Local shares have zoomed 43% higher since September 2023. But as a long-term investment, the case remains unproven. Stock markets rise and fall, but most trend upwards. It is the reason investing has a better reputation than gambling. Yet China's equity graph really does resemble a roller-coaster, with long climbs followed by hair-raising plummets.

China is far from the only emerging market to exhibit a disconnect between GDP growth and equity returns, although its case is especially extreme. The exact causes are much debated.

One important factor is simply that investors adore a good emerging-market growth story. That causes valuations to rocket, front-loading years of earnings growth into current valuations (something that current buyers of expensive Indian shares would do well to bear in mind).

A second reason is that many of the gains from growth tend to be captured off stock markets, particularly by landlords. Just imagine the fairy-tale returns from holding a patch of land in Shenzhen, an impoverished collection of fishing villages that blossomed in two decades into the centre of global technology manufacturing.

China's property bubble has burst

The gains to be had from property weren't lost on the Chinese. Newly wealthy Chinese households had few other investment options. Bank deposits pay miserable returns. Foreign shares are off limits, and the local stock market is volatile. So they went massively for bricks and mortar, buying second and third homes as investments. When built, these assets were often not even rented out, lest tenants detract from the much more important objective of maximising capital gains.

What followed was a property boom for the ages. During three years in the 2010s, China used more cement than America employed in the entire 20th century. The bubble was clearly getting out of hand. In 2020-2021, officials called time by imposing stricter caps on leverage. Property developers went to the wall, most famously including giant Evergrande, which imploded with $300 billion in liabilities. In 2023, Reuters estimated there were 7.2 million unsold homes. National property prices fell 40% between 2021 and 2025. That was devastating for a middle class that holds nearly 70% of its wealth in property. The property-shaped cloud over sentiment has yet to lift. In January and February, retail sales endured their weakest two-month start to any year since 2000 outside the Covid era.

There are plenty of other concerns for those looking to invest in China. The country's fertility rate is running at close to one child per woman, making it one of the world's most rapidly ageing societies. And a 2021 crackdown on tech firms (now largely reversed) was a reminder that all businesses ultimately operate at the pleasure of the Communist Party.

How China learnt from Japan's mistakes

Since the property bust, many economists have noted parallels between China and Japan. During the 1980s Japan was regarded as the world's most technologically advanced nation. Following the crash in the 1990s, its corporations slowly began to slip behind, failing to capitalise on the rise of the internet. But it looks as if China will avoid Japan's fate.

Tokyo spent the 1990s pouring money into zombie firms; in 2021, Beijing pulled credit from property and redirected it with military zeal towards the “New Productive Forces”, official jargon for things such as electric vehicles, rare earths, batteries, green technology and AI. Chinese companies are now conquering new global markets with terrifying efficiency. One in seven cars sold in the UK this year was Chinese, up from 1.3% just five years ago. Britain's top-selling car is currently the Jaecoo 7, a brand that almost nobody had heard of until recently.

China's critics have long pointed to what might euphemistically be called the country's relaxed attitude towards other nations' intellectual property. But China's days as a mere imitator of Western inventions are ending. As economics commentator Noah Smith notes on Substack, Chinese firms now know how to do things that Western companies simply can't replicate. Nowhere else has such a dense clustering of electronics and tooling engineers. Chinese firms are opening factories in other countries, and those factories are proving more productive than the foreign competition. Soon, the Germans will be copying the Chinese.

Better ideas are only one part of the equation. The other is lavish levels of state support, especially in the form of never-ending credit lines. Chinese factories are producing too much. The country's global export dominance – the trade surplus reached $1.2 trillion last year – is a symptom of the fact that there aren't enough domestic buyers to soak up a glut of batteries, solar panels and especially cars. China's manufacturers have turned to world markets not out of strength so much as desperation; razor-thin profit margins mean they are fighting to keep the lights on. China's industrial strength and its chronic deflation are thus two sides of the same industrial-policy coin. You might argue, as Smith does, that China is simply making a huge capital-incinerating mistake. But you might also argue, as Jeremy Warner does in The Telegraph, that given the choice between wasting capital on excess industrial capacity and wasting it on unsustainable welfare, as the West does, China is making the better strategic choice. Chinese industrial policy makes a lot more sense “if your objective is that of enfeebling the US... while insulating China against the sort of supply-chain vulnerabilities we see buffeting Western economies”.

Should you invest in China?

Will Chinese shares prove a good investment over the next ten to 20 years? Given the historical record of equity returns, the jury is still very much out. What does seem less likely today than even a few years ago is a repeat of the Russian experience, where foreign investments were effectively zeroed out following Vladimir Putin's invasion of Ukraine.

In 2022, the parallels with Chinese assets in the event of a Taiwan conflict seemed obvious. But the world has changed. It is far from clear that Donald Trump's America would stand in the way of a Chinese invasion across the Taiwan strait, and even harder to believe that the UK, acting in solidarity with the US, would cut off trade with China, the world's second-largest economy, as aggressively as we have sanctioned Russia, a comparative minnow.

Taking a one- to three-year view, the Middle Kingdom looks a reasonable bet. Firstly, because China's newfound coolness might just be a foretaste of a “vibe shift” about to occur in the market. Markets have always traded on narrative as much as cold, hard facts about Ebitda, and over the past decade, the rise of social media has only amplified this trend (how else can we explain car-maker Tesla's current price-to-earnings ratio of 324 times earnings?). Secondly, unlike Tesla's stock and its ilk, China has genuine value appeal. The MSCI China index trades on a very reasonable 11 times forward earnings, which should cap downside risks if anything goes wrong.

Punting the whole pension on Shanghai would be imprudent, but a trade that ticks both the momentum and value boxes deserves to be taken seriously. In 2026 the meme winds are blowing in favour of China. Given the entry price, it seems foolish not to lean into it.

The best ways to invest in China now

Before investing in China, it's worth auditing your current exposure. Enthusiastic buyers of emerging-market funds may well discover that they already have quite enough Chinese shares. As much as a quarter of many emerging-market trackers and funds are allocated to China. And for those nervous about conflict in the Taiwan strait, note that soaring semiconductor valuations have recently seen Taiwan's share of the emerging-market sector balloon, in some cases to another fifth or more of many funds.

By contrast, investors with a bias towards developed markets may be underweight China. China accounts for a mere 2.9% of the MSCI ACWI index (ranking behind the economic juggernaut that is Mark Carney's Canada). Compare that with China's 17% share of global GDP. There are sensible arguments for why Chinese markets shouldn't take up that much of a typical equity portfolio, but a 2.9% allocation is much too low for a country that is seizing the high ground in so many of the industries of the future.

The three leading active China trusts are Fidelity China Special Situations (LSE: FCSS), JPMorgan China Growth & Income (LSE: JCGI) and Baillie Gifford China Growth (LSE: BGCG). The funds have more similarities than differences, with each having put in a similar performance over the past 12 months, and a rising tech tide driving gains of about 25%. JPMorgan pays out a 4.7% dividend.

There is a solid case for active management in China, where Western investors will want to load up on tech and consumer shares, while steering clear of state-owned banks and low-quality firms. Fidelity has the best long-run record, but its slight tilt towards small and medium-sized firms may not be the best play at a time of relentless domestic deflation. Baillie Gifford, which has more of a growth bias, fits the bill better for those seeking a tactical momentum play.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

Matthew Partridge: What prompted your book?

Ram Charan: I have been working in China for more than 20 years with American, European and Chinese companies; in some cases I was on boards as a director. The wake-up call was when I noticed that one US firm, which had a dominant position in the Chinese market, saw its market share begin to decline. Next, its unit costs went up and then the Chinese Communist Party basically forced them to sell their business to the Chinese.

This caused me to realise what China is trying to do – produce 90% of the global output in a sector, using a combination of subsidies, currency manipulation, and artificially cheap land and capital, and then using this to gain a cost advantage over the rest of the world. This strategy has already been applied to achieve a stranglehold over ten sectors in the past five years. This in turn creates a trade surplus, which is propelling China's military. It's a very sophisticated economic model, which essentially runs China as a conglomerate like General Electric.

The public may love it because it produces an endless supply of cheap goods. But in the longer run it means that non-Chinese companies cannot compete with China. And if war breaks out, this could become an existential issue.

MP: How likely is war between China and the US?

Ram Charan: We are already at war. The US House of Representatives Select Committee on China said it explicitly in October 2025: this is a war of mutual destruction; economic, technological, existential. The trigger will not be a single event. Cumulative economic strangulation will reach a breaking point. Xi has built something more powerful than an invasion: asymmetric chokehold capability. China can now shut down whole industries in America and Europe at will by controlling rare earths, battery components, semiconductor materials and advanced chemicals.

When Beijing announced requirements for export licences in October 2025, Donald Trump responded with 100% tariffs. The countdown has started. The real trigger is industrial collapse. When CEOs in the US realise they can't build anything without Chinese inputs, including defence systems, the political pressure for confrontation becomes unstoppable. Taiwan is the flashpoint everyone watches. But the invisible trigger is America losing the capacity to respond militarily because China controls the supply chains for defence manufacturing itself. China is stockpiling wheat, oil, commodities, and building the world's largest navy – 370 ships versus America's 290. It is expanding its nuclear arsenal to 1,000 warheads by 2030, and aligning with Russia and North Korea in a trilateral axis that can strike the US mainland in 30 minutes.

Xi Jinping is lighting proxy fires in Ukraine and the Middle East through local actors to stretch US military resources. Xi would prefer America to concede without firing a shot, but he is prepared to fight if the US does not yield. Unless America rebuilds industrial capacity fast enough to break China's chokehold, conflict is certain within the decade.

Matthew Partridge: What should the US do to combat the threat?

Ram Charan: Both the US public and firms must understand they are not competing with individual Chinese companies, but with the nation. And they can't compete alone. There must be more collaboration among both countries and firms. I have suggested that Trump create a Department of Manufacturing and Technology, whose full-time job is to co-ordinate, integrate and plan in a similar way to how the Pentagon organises the defence sector to fend off an equally powerful opponent.

Matthew Partridge: Didn't industrial policy fail when the UK tried it in the 1960s and 1970s? Witness British Leyland.

Ram Charan: British Leyland failed because bureaucrats picked products and ran factories. What I am advocating is government staying strategic, not operational. The Chips Act is an example. Government subsidises semiconductor making. Intel, TSMC, Samsung decide what to build and how to run operations. Government creates conditions for private companies to compete against state-subsidised Chinese opponents.

However, in addition to subsidies and support you will need enforcement of basic trade rules. Stop the dumping. Counter the currency manipulation that gives China a 20%, unbeatable pricing advantage. You also need to change US CEOs' psychology. They still think “cheaper currency, cheaper labour” is how you win. Move up the value chain. Import technology and equipment, not consumption goods. Scale up medium-sized manufacturers with AI and automation.

This is about national security. China has destroyed key US industries, including furniture, apparel, solar, rare-earth metals and ship components. The next targets are AI, biopharma, aerospace, advanced semiconductors, and chemicals. If those fall, America cannot defend itself. This is not industrial policy as socialism. This is industrial policy as survival.

Matthew Partridge: How can you ask other developed countries to work together under US leadership given that Trump has imposed high tariffs on them? Isn't that going to make them less likely to cooperate?

Ram Charan: I think people misunderstand Trump's approach. While it's true he has imposed tariffs, and this has created a lot of confusion, he has done this to rebalance trade between the US and the rest of the world, eliminating the large US trade deficit with most countries. Once this is achieved, his aim is to reduce these tariffs by as much as possible. Already small countries like Oman face barriers of as little as 2%. The idea is to bring countries to the table to discuss the issue, not protectionism for protectionism's sake. US tariffs will decline as the other sides reduce their barriers to US goods.

Matthew Partridge: You say that you are confident about the US because of the openness of its system and because of its big research infrastructure. But Trump has undermined this advantage with immigration controls and cuts to research budgets. Many of Trump's policies seem counterproductive.

Ram Charan: I agree that they are counterproductive. And that's honestly something I don't understand. Maybe it's due to his own ideological belief, but attacking universities is not consistent with his aim to reindustrialise the US.

Matthew Partridge: Moving from countries to companies, is it fair to say that investment in China is a double-edged sword? Many firms are being forced to give up their intellectual property (IP) in exchange for cheap labour and access to Chinese consumers.

Ram Charan: Yes, it is a double-edged sword. Not only will they steal your IP, but once a Chinese company shows signs of winning significant market share, Beijing will back it to the hilt, and give it a huge amount of resources to expand further, so it starts to drive you out of the market. The next thing, you notice you are making losses and decide to leave, or you get a call “inviting” you to sell up – as Starbucks and many others have done. Beijing's attitude, particularly in industries it has explicitly targeted, is that “until we get our own capability, you are our guest”– but once China starts to build its own domestic capacity, the Westerners are either asked to leave or driven out.

Some of the smarter companies started to work this out about ten years ago, and reconsidered their global strategy, including discreetly building up their operations in other countries, such as India. As a result, they are now doing very well, with their Chinese rivals still lagging behind due to the fact that they have not accumulated the necessary expertise that they would have gained from having a Western firm in their midst.

Matthew Partridge: What does India needs to do to become an attractive alternative to China for Western companies?

Ram Charan: In order to attract Western firms fleeing China, India needs to put its house in order. This includes smashing bureaucracy to make it easier for them to operate. India also needs to have better training in manufacturing, because manufacturing requires quality and reliability, and Indian firms have to learn to match customer specifications.

That said, India has some companies that are number one in the world. This includes Bajaj and TVS, which have done a great job of producing quality scooters, as well as other two-wheelers. So India needs to build on this to climb the value chain into products like semiconductors.

Matthew Partridge: Are there any other companies that stand to benefit from Western companies relocating from China?

Ram Charan: Every developed country will benefit from re-shoring to reduce dependence on China. Among developing countries, the other big winners will be Vietnam, Mexico and Indonesia. However, for companies, the solution is not substitution but diversification to break coercive power.

After all, Mexico and Vietnam are also proxies for Chinese production – Mexico's trade with China exploded after Trump's tariffs as Chinese companies set up Mexican operations to bypass US trade barriers. You must audit the entire supply chain. Where do the components come from? Who owns the factory? Where does the capital flow? Companies waiting for a single “China alternative” will wait forever.

Ram Charan has spent 30 years advising Fortune 500 CEOs on China. His latest book, China's 90% Model: China Has America by the Throat – Here's How to Fight Back and Win, is published by IdeaPress Publishing.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

How should we tackle our anaemic productivity growth? Two answers have emerged: “Build Something Now”, and “Innovate Faster”. Chris Clothier, fund manager at CG Asset Management, recently put the case for the former when he noted that Britain “ranks... last among the G7 for gross fixed-capital formation, at about 18% of GDP annually. The range for the rest of the G7 is 20%-25%”.

Perhaps the most eloquent exponents of this school of thought are two Americans of the centre-left, Derek Thompson and Ezra Klein. Their book Abundance – very relevant to the UK – posits that the left in the US has championed excessive regulations and administrative burdens, which have severely hampered America’s ability to build essential things society needs, such as affordable housing, modern infrastructure and clean-energy systems.

The result is a system where completing important projects – such as building new homes or advancing green technology – is hampered or blocked entirely by layers of reviews and regulations. They point to Republican states where the balance is right – places such as Texas have built more homes and more jobs.

Unsurprisingly, this agenda has also attracted interest from Republicans, but the message is clear: America (or the UK) needs to build more infrastructure (and create more jobs) and homes, so that people can enjoy greater abundance. This agenda is being replayed here in the growth caucus of Labour MPs, who are making similar arguments: more homes, more green power infrastructure, more nuclear power, less regulation.

The argument is echoed in another influential book released this year, Breakneck, by technology and China analyst Dan Wang, who previously worked for research firm Gavekal. He compares the US, run by lawyers who often hinder the construction of new things, with China, run by engineers and scientists who focus on building assets such as trains, industry and homes at a rapid pace. His arguments about how long it has taken California to build a high-speed rail system are echoed in the omnishambles surrounding HS2.

How to boost productivity

However, mobilising additional capital to get things built, which in turn helps boost GDP growth (through more construction jobs, for instance), is far from a panacea. Although numerous studies show that additional investment in fixed-capital projects boosts growth (via so-called multiplier effects), these follow-on impacts have declined over the years, perhaps a result of increasingly burdensome regulations.

A rival school of economists and policymakers argues for a different approach. They tend not to disagree with the idea that less regulation is beneficial, and don’t deny that investment is essential. However, they prioritise the importance of what we might call “soft capital”: knowledge and governance. You can see this approach clearly in a recent paper from the UK’s leading economic research organisation, the National Institute of Economic and Social Research (NIESR). In an ambitious collaboration between productivity and growth experts, the NIESR collated a range of views about how to kick-start productivity gains.

The professors and academics suggested more investment in skills training, prioritising vocational and technical training through retraining programmes and flexible learning, supported by the Growth and Skills Levy. They also argued that the UK should support digital transformation of the public sector, ensuring universal access to digital services and mandating digital readiness for all policies.

Low public-sector productivity growth is a crucial problem that every politician likes to talk about, but few offer practical solutions. The academics also focused on what they called fragmented decisionmaking, short-term budgeting and an “overcentralised yet undercoordinated” Whitehall machine, “blocking the very productivity gains on which the government’s economic strategy relies”.

Investment in physical assets, such as roads, and urban transport, such as trams, does get a mention, alongside a commitment to keep public investment at around 4%-5% of GDP (the average since 1987 has been under 3%). But the skew is clear. Building things won’t solve the problem – skills and innovation are crucial. The most explicit exponent of the “Innovate Faster” school is Daniel Susskind, an Oxford economist who published a superb book last year called Growth: A Reckoning.

Like many, he’s sceptical about the view that simply building many things will make much difference. Instead, he suggests that working with the same physical capital, but making that capital work harder, is the key to growth. In policy terms, that might mean significantly increasing spending on research and development (R&D), fostering innovation hubs, and generally improving the workforce’s skills.

If, like Susskind and Co., you favour boosting skills and innovating more, then you need to accept that there are no quick fixes or populist freebies. Improvements in innovation and the skills base require long periods of focused change and investment, and are very far from commanding headlines. At present, the best model for this is China. Its Made in China 2025 technology plan has transformed China into a technology superpower. The downside is that in the process, it’s also almost certainly wasting countless tens of billions backing the wrong projects and plans.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

In the late 1990s, a young Stella Li landed in Rotterdam from China with $30,000, a container load of lithium-ion batteries and an order from head office: “sell them to survive”. She clinched a deal with Nokia, then the number one mobile-phone maker. Never one for false modesty, she told the Financial Times: “I opened the door and moved BYD to another level.”

Nearly 30 years on, the company has moved far past its roots as a battery maker to become one of the world’s most powerful manufacturers of electric vehicles. Globe-trotting Li remains so firmly at the heart of its international expansion that colleagues have dubbed it “The Stella Show”. Yet the stakes, while much higher, are just as existential. BYD sales grew by 40% last year, but it is having to grapple with both rising Western protectionism and a darkening domestic outlook in China in the teeth of cut-throat competition. It’s going to be “very difficult for BYD to continue to grow the way it’s been growing”, says analyst Tu Le of Sino Auto Insights.

“A diminutive woman with almost frenetic energy,” Li, 55, “zips across the globe furiously, rarely making it back to her current home in Los Angeles”, says Fortune. In a typical day, BYD’s “crucial ambassador and strategist” might wake up in Istanbul, fly to a meeting in Vienna and then spend the night in Germany. The carmaker now exports to roughly 95 markets, but Europe is particularly crucial to its global push. In markets such as Britain – which this year became BYD’s biggest outside China – the company has become “Elon Musk’s worst nightmare”.

At its heart, BYD – which was founded in Shenzhen in 1995 by Wang Chuanfu – has always been a partnership. While Li led marketing and expansion, Wang, 59, was the engineer behind the group’s rapid technological advancements and manufacturing prowess. He never wavered from his dream of building electric cars, even when it looked like a long shot. The pair met soon after Li had graduated from Shanghai’s prestigious Fudan University and the relationship developed romantically as well as commercially.

BYD stands for “Build Your Dreams”, but back in the early days when Li was pestering mobile-phone executives in Atlanta suburbs with her box of battery samples, she used to joke that it stood for “Bring Your Dollars”, says Bloomberg Businessweek. Her great strength then was persistence. It took her two years to win a contract from Motorola. But by 2002, when BYD went public in Hong Kong and Shenzhen, the company was on a roll. Many investors were furious when Wang bought a majority stake in a failing state-owned carmaker a year later – appalled that BYD “was wading into a market it knew nothing about”. At the time, Wang didn’t even know how to drive, but was convinced that electric cars were “a natural extension” of the battery business.

The first clunky models did nothing to dissuade the critics, but Wang continued to pour cash into product development.

Stella Li's deal with Warren Buffett

The deal that put BYD on the map was Berkshire Hathaway’s landmark $232 million investment in 2008, says the FT. Li was introduced to Warren Buffett and Charlie Munger by her friend Li Lu, a billionaire hedge-fund manager. In the nearly two decades that Berkshire stuck with BYD until completing its exit this year, it reportedly netted a return of about $7 billion. In that time, BYD has achieved what Tesla, Ford and the rest of the car industry haven’t, says Businessweek: “build an affordable electric car for the masses and make money doing it”. Jean-Francois Baril, chair of Nokia’s owner HMD Global, who has known Li for more than two decades, credits her with “bridging the East and the West”, says the FT. She’ll need all that skill to keep BYD on the road in the years ahead.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

After World War II, America and its allies put in place a set of alliances, institutions and power structures to rebuild war-ravaged countries, create geopolitical stability and generate global economic growth. This post-war order has endured – with one important change – for much of the following eight decades.

The fall of the Berlin Wall and the dissolution of the Soviet Union seemingly marked the end of any alternative to Western capitalism and liberal democracy as the main global economic system. However, in recent years, it has become increasingly obvious that the ties holding this US-dominated system together are fraying and are likely to break.

We are heading into a new world that is likely to be more unstable. In a symbol of this change, on 5 September this year, US president Donald Trump signed an executive order renaming the Department of Defence as the Department of War. This restores the name that it carried from 1789 until 1947 and points to the rising risks of conflict in the years ahead.

So how should investors position themselves for what comes next? What areas that are currently under-represented in most portfolios should they consider for diversification and protection?

Rivalry and conflict between the US and China

The main question is how the shift from a single superpower to two contending nations – the US and China – will affect global supply, demand and the efficiencies of comparative advantage. Free trade has generated huge gains since the end of the Second World War, and even more so since the end of the Cold War. This is now clearly under threat.

With the end of the post-war order comes the new “Great Game”. This name was originally given to the struggle between Britain and Russia for influence in Central Asia (Afghanistan and Persia). This time, the strategic rivalry and political conflict is between the US and China. Paradoxically, it is America that is now pursuing a more inward-looking strategy under Trump’s Make America Great Again (MAGA) banner, while China aims to build economic and political alliances through its Belt and Road (BRI) and Global Development Initiative (GDI) projects.

While America strives to bring its manufacturing base back onshore, Europe is now having to divert budgets from social welfare to rearmament. Both are now in stiff competition with China to electrify the planet and build digital infrastructures. This will inevitably lead to global competition for resources across energy, metals and critical minerals.

This is leading the two superpowers to weaponise their core strategic advantages. For America, this is the US dollar, still the world’s global reserve currency. For China, it is a stranglehold on rare earth elements and critical minerals.

China needs an alternative to the dollar

Freezing and confiscation of assets and denial of access to global payments systems is forcing non-US aligned countries to look for an alternative store of wealth and means of exchange. Herein lies the potential significance of the Brics+, the informal name for the original group of five key emerging-market powers – Brazil, Russia, India, China, South Africa – plus other countries that have begun joining them for summits and policy coordination. Some see this group as a counterpart to the G7 group of developed economies. Initiatives by the Brics+ members so far include work on a development bank, central-bank cooperation and an international payment messaging system.

Any alternative to the dollar looks increasingly likely to be a form of tokenised, asset-backed digital currency. This explains why many central banks closely aligned with the Brics+ nations have been large buyers of gold and other precious metals.

If the creation of a new currency system seems far-fetched, it is worth a quick review of the genesis of the post-war order: the Bretton Woods Agreement of 1944. China is a great student of history, and this agreement provides an template for how new world orders are created. While World War II was still raging, more than 700 delegates from 44 countries met at Bretton Woods in New Hampshire in the US to work on a new global monetary system. The goal was to create a globally efficient foreign exchange market, prevent competitive currency devaluations and promote global economic growth.

John Maynard Keynes, one of the principal economists at the meeting, proposed creating a new international reserve currency called the “bancor” and setting up a global central bank called the “Clearing Union”. However, these proposals were eventually watered down by the US Treasury in favour of a more prominent role for the US dollar, whereby the dollar would be pegged to the price of gold, and other participating currencies would be pegged to the dollar. The agreement was fully implemented in 1958, pegging the US dollar to gold at $35 per ounce.

This system functioned until the early 1970s when it became evident that US gold reserves were not adequate to sustain the peg. This caused a run on gold, forcing first a temporary suspension of the dollar’s convertibility into gold followed by complete collapse of the agreement in 1973. US president Richard Nixon also imposed a 10% tariff on all dutiable imports to force its major trading partners to adjust their currencies upwards and trade barriers downwards. Does this sound familiar?

China has already taken the strategic initiative to convene the Brics+ group of nations. It has established the Shanghai Gold Exchange – and associated physical storage – and now holds a significant percentage of its reserves in gold. It has shown little desire to replace the dollar with its own currency – internalisation of the renminbi would erode the ability to operate capital controls – but it and its allies need an alternative to the dollar.

Given China’s embrace of technology and advanced domestic digital-currency adoption, it does not feel far-fetched to envisage it launching a Bretton Woods-style gold-backed digital currency for those unable or unwilling to access the US dollar system. Crypto tokenisation is the vehicle, not the asset.

China's control of strategic resources

China’s strongest bargaining chip lies in its control of rare-earth elements (which are used in magnets, electrification, lasers and optical devices, catalysts and emission controls and radar/guidance systems), as well as critical minerals, that have broader energy, industrial and defence applications.

China has this control because, while the West focused on the comparative advantage of outsourcing its production to countries with lowest costs, China focused on building an end-to-end supply chain comprised of exploration, mining, refining and industrial manufacturing. With its looser environmental controls, it has come to dominate the global supply of these critical minerals.

In the tit-for-tat game of tariffs and sanctions, China is able to leverage its position in the one area where the US is completely vulnerable. So just as China and its allies have no alternative but to develop a competitor to the US dollar as a store of wealth and means of exchange, the US and Europe now see they have no choice but to develop alternative sources for mining and processing capacity to break this reliance. Exacerbating the situation, America’s prioritisation of its own MAGA agenda over historical alliances has left Europe and other previously US-aligned countries to build their own rather than collective resources.

If investors believe the post-war order is irretrievably compromised, they should consider investments that give exposure to these themes. Gold and precious metals for hard assets. Tokenisation and chips to enable digitalisation. Energy and power generation, rare earth elements and critical minerals, which will be in demand as both sides try to secure supply chains. And US and European defence stocks as the West joins in the new arms race.

Investors have many ways to access these ideas, including individual stocks, thematic exchange-traded funds (ETFs) or exchange-traded commodities (ETCs) that hold physical metals. Listed commodity futures and options are also becoming increasingly accessible, as major exchanges such as the Chicago Mercantile Exchange (CME) roll out mini and even micro contracts, which are 1/10 or 1/100 of the size of standard contracts and require less up-front capital. Such instruments are only suitable for experienced investors, but they offer a way to quickly add hedges or speculative positions to a portfolio – something that will become more valuable in a fast-changing world.

James Proudlock is managing director of OptionsDesk.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

I repeatedly come back to this subject because I think it is one of the most important yet overlooked issues in global finance. The geopolitical ramifications are enormous. Something that the Trump administration appears to understand in a way that previous administrations didn’t is this: it doesn’t matter if you issue the global reserve currency; if you don’t make anything, when the tide goes out, you are going to be caught swimming naked.

During Covid, the dangers of excessive dependence on China and its supply chains for critical or strategic products became apparent. It became clear again during the Ukraine war. Russia managed to manufacture munitions much faster than Nato.

Reshoring US industry is not something that can be done overnight. It is going to take years, if not decades – almost as long as it took to unwind in the first place. But the Trump administration is at least trying to kick-start the process with tariffs, a weaker dollar and, more subtly, the managed decline of the US dollar as global reserve currency.

As a result, neutral gold’s role as a global reserve asset is returning to prominence. History’s “golden” rule will soon apply again: he who has the gold makes the rules.

My argument is that China has considerably more than the 2,300 tonnes it says it does. That figure constitutes the world’s fifth-largest reserve of the yellow metal. The central banks of the US, Germany, Italy and France are the top four holders of gold reserves, with respective 8,133, 3,350, 2,451 and 2,437 tonnes.

How much gold does China have?

The People’s Bank of China (PBOC) is China’s main custodian, but other state entities, such as the China Investment Corporation (the sovereign wealth fund), the State Administration of Foreign Exchange and the Army, also own gold. In fact, having other state bodies hold gold is one of the means by which China is able to understate its reserves.

I’m going to use a slightly more conservative methodology, which means I will arrive at a lower estimate. Even so, the numbers will shock you. Remember that China is the world’s largest importer of gold, the largest consumer and the largest producer (in 2008 its output eclipsed South Africa’s). I am going to use round numbers, as they are more digestible, and when there is a spread (between 500 and 1,000 tonnes, say), I will take the middle number: 750.

It is impossible to know just how much gold China has imported, because so many transactions are private ones, particularly those that go through London, Switzerland or Dubai. Gold transactions in Hong Kong are more transparent.

However, most, although not all, of the gold that goes to China goes through the Shanghai Gold Exchange (SGE), which opened in 2007. Withdrawals from the SGE between 2007 and mid-2025 total 29,500-30,000 tonnes, based on aggregated data from the Shanghai Gold Exchange (SGE) and World Gold Council (WGC) reports. I’m going to overlook gold that made its way to China prior to 2007, although it’s quite easy to make the argument that this amounts to several thousand tonnes.

The SGE is just a flow metric, it should be noted. It does not represent total consumption. Some of the gold passing through will have been double-counted, either as a result of reselling and recycling, or because of China’s booming money-laundering business and the circular trade with Hong Kong. Estimates for double-counting range from 10%-30%. Let’s take the middle 20% figure (6,000 tonnes), and that leaves us with 23,250 tonnes of SGE gold.

As for the undisclosed gold, consider that the PBOC likes 400-ounce bars, as traded in London. These do not trade on the SGE, which uses smaller kilogram bars and 3kg and 12.5kg ingots. (400oz is about 11.3kg.)

So London imports will not go through the SGE, unless re-smelted, and are therefore counted in addition to the numbers above. Analysts mostly concur that while reported imports via London, Switzerland and Dubai total between 3,500 and 4,500 tonnes, another 3,000 tonnes (mostly post-2009, accelerating since 2022) have gone unreported. Add the 3,000 tonnes to the 23,250 of SGE gold and our total is now 26,250 tonnes.

Gold mining in China

Around 55% of Chinese gold production is state-owned, and we know from geological records that this century, China has mined roughly 7,500 tonnes.

Between 70% and 80% of Chinese production is sold through the Shanghai Gold Exchange, so we have already counted that. The other 20%-30% goes to the state. Using estimates from the mid-range, 25% of those 7,500 tonnes (1,875 tonnes) has gone to the state. The rest has been sold through the SGE. Add 1,875 tonnes to the total, and we reach a figure of 28,125 tonnes.

By the way, I have not included overseas Chinese gold production, of which there is a lot. Some of this gold is sold on international markets and never actually reaches China. But what does reach China is sold through the SGE and has therefore already been counted. Finally, we have to add in gold held in China, whether as bullion or jewellery, prior to 2000. The WGC estimates a figure of 2,500 tonnes in privately held jewellery. Added to domestic mining and official reserves, you get a figure of around 4,000 tonnes. This brings our grand total to 32,125 tonnes.

Demand for gold

Previously, I have argued that 50% of that gold would go to the state. That would mean roughly 16,000 tonnes – almost twice as much as the US’s reported 8,100 tonnes! Let me propose another methodology.

It stems from my conversation with Konstantin Kisin in the Triggernometry podcast a fortnight ago. Last year, investors and central banks comprised a respective 25% and 23% of overall demand for gold; the figures for jewellery and industry are 47% and 6%.

These figures of course change from year to year, with demand from investors and central banks being the big variables. But if we assume demand from China roughly matches global demand, that would mean that of the 32,125 tonnes, roughly 15,100 tonnes is jewellery; 8,030 is now bullion held by investors; 1,930 tonnes went into manufacturing; and the Chinese government has 7,400 tonnes.

This assumes Chinese gold has been allocated over the last 25 years according to the global habits of last year, which is almost certainly a bogus assumption. China is such a big manufacturer that demand from the Chinese industry may well be higher than 6%.

It’s also easy to argue that because the Chinese people like gold so much, and the state has been encouraging them to invest since 2007, that both Chinese jewellery and investment demand is higher than 47% and 25% respectively.

Similarly, because of dedollarisation, demand from the PBOC could be higher than 23%. In any case, I have been transparent about my methodology.

You can make up your own minds. The upshot is that China’s stated reserves of 2,300 tonnes are a gross underestimate.

In a way, it’s actually better for investors if China has less gold, because it means they have more buying to do, and that should help drive prices higher. Meanwhile, the Middle Kingdom’s stated 2,300 tonnes only account for 7% of its $3.4 trillion of overall reserves. To get above 70% and match the allocation ratios of the US, Germany, France and Italy, at $4,200/oz gold, it would need something like 18,000 tonnes. That’s a lot of buying yet to come, in other words.

If you take my assumption from previous years (that 50% of the gold that has gone to China via imports or production went to the state), then China has 16,000 tonnes of gold. That is twice America’s reported holdings of 8,133 tonnes.

This comes just as gold, at current prices, accounts for 30% of global foreign-exchange holdings, according to Deutsche Bank. The US dollar, meanwhile, makes up 40%. The euro’s proportion lies below 20%. This is quite the move: gold’s share was just 20% at the beginning of the year.

At $5,800 – a 33% rise from today’s price of $4,340 – gold overtakes the US dollar to become central banks’ largest holding. That assumes banks don’t buy any more, of course, when they will. A recent survey by the WGC found that 43% of central banks plan to increase their holdings over the next year, while 95% of reserve managers expected global central-bank holdings to rise over the next 12 months.

I was looking for parity between the dollar and gold in terms of reserve holdings at some stage in the next decade. We could see it within the next six months on current trajectories.

Why is China keeping its gold a secret?

And gold isn’t money, according to former Federal Reserve chairman Ben Bernanke. So why does China understate its reserves? China is still in accumulation mode. While it is buying, it wants the price low.

It certainly doesn’t want to cause it to spike.

If China were suddenly to say that it actually has 7,400 or 16,000 tonnes, rather than 2,300, it would send the gold price rocketing. More significantly, it risks sending the dollar into a plunge. China has $3.4 trillion-worth of dollars. It wants to preserve their value, presumably.

In short, coming clean on gold holdings would create enormous financial upheaval. It has that card, ready to play, should it ever need to, should it ever get into conflict with the US, for example. Money is the first thing that gets weaponised in war.

But for now it doesn’t need to. China is surely happy growing as it is, making things and selling them to the rest of the world, thus ensuring that the rest of the world becomes dependent on it. Why rock the boat? It’s on to a good thing after all.

“We must not shine too brightly,” as Deng Xiaoping is once supposed to have said. I understand that what he actually said amounted to “keep a low profile”, or “don’t draw attention to yourself”. Same difference. China doesn’t want to rock the boat, particularly while it’s still accumulating gold.

This is quite a shift that is taking place, and it is happening quickly. The upshot? You really want to own gold, overbought or not.

Dominic Frisby writes the investment newsletter The Flying Frisby (theflyingfrisby.com). His latest book is The Secret History of Gold: Myth, Money, Politics & Power, published by Penguin Business and available from all good bookshops.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

Andrew Van Sickle: After more than a decade of poor performance, emerging markets (EMs) have staged a comeback this year. The benchmark MSCI EM index has gained more than 20% in US dollar terms. What has brought out the bulls?

Gustavo Medeiros: I think there are three key drivers here. The first is that we had historically low valuations at the start of the year. The second is that over the last 18 months or so, earnings per share have started to climb, helped by healthy growth in several countries and buoyant industries such as AI and semiconductors.

Earnings per share in the MSCI EM Index are now expected to rise from $80 to $96 or so this year. Profit growth has eclipsed that of the MSCI World index over the past four quarters. The third source of support is the weaker US dollar.

Andrew Van Sickle: That usually bodes well for EMs, which are risky assets; a buoyant greenback, along with high US interest rates, bolsters the appeal of safer US assets. Have global investors become disillusioned with America?

Gustavo Medeiros: America has the world’s reserve currency and the deepest capital markets in the world. So the key determinant of global asset allocations will be how the biggest market is performing in absolute and relative terms. High valuations and the tariffs on “liberation day” unnerved investors, reminding them that they needed to diversify away from the US. Structural improvements in developing economies, notably lower inflation, and a shift to pro-market policies post-pandemic, have also helped bolster sentiment. There have been more upgrades than downgrades of EM sovereign debt for some time now, for example.

Meanwhile, although EMs are traditionally comparatively dependent on trade, with large shares of exports as a percentage of GDP, Liberation Day at least tempered the uncertainty. It became clear that tariffs would not fall below 10% but were also unlikely to exceed 30%. On paper Mexico and Vietnam are the most vulnerable, with exports to the US worth 25% of GDP in each case – although a pre-existing Trump-originated deal in the former, and a strategic partnership with the US in the latter, tempers risk. Their stock markets have rallied 40% this year, as have those of Southeast Asia, the next most vulnerable economies.

Andrew Van Sickle: Shall we take a closer look at the structural changes in EMs, a recurring theme for 10 to 15 years now? Everyone used to think of EMs as commodity-exporters heavily geared to global growth, but there’s far more to the story these days.

Gustavo Medeiros: Yes, there is a wide array of supportive factors. In Asia, India and Indonesia are two examples of major economies that have gained momentum through structural reform. Chinese technology, chipmaking in Taiwan and AI are also boosting EM growth. In Latin America, there are many high-quality undervalued companies that have embraced digitalisation and have enormous target markets, yet politics has obstructed the investment opportunity. A series of coming elections are likely to result in a shift towards a more free-market approach, which bodes well for profits and interest from global investors.

Peripheral Europe and central Asia should benefit from a strong boom in capital expenditure on defence, energy and infrastructure coming from Europe, a result of Europe’s attempt to become more self-sufficient. Meanwhile, a round of fiscal consolidation in Ghana, Nigeria and Egypt, following the tight squeeze imposed on Argentina by president Javier Milei, is good news for some of the smaller, more exotic markets.

Andrew Van Sickle: I remember being struck, during the pandemic, by EM central banks being quicker off the mark when it came to squeezing out inflation by raising interest rates than their developed-market counterparts. Overall economic management has improved greatly in EMs.

Gustavo Medeiros: Economic policy has been much better, much more sensible over the past five years in EMs. They raised rates rapidly to counteract the global boost to inflation and avoided quantitative easing; they were mostly restrained when it came to fiscal stimuli, too and quicker to consolidate their deficits. They clearly learnt from the debt crisis of the 1980s and 90s and opted for prudence this time. That leaves them well-positioned for strong and sustainable growth.

Andrew Van Sickle: Let’s zoom in on some of the major economies and markets now, starting with China. A drift towards authoritarianism and the fear that it could turn into another Japan have been two key bearish factors. How would you assess the situation?

Gustavo Medeiros: One simply has to factor in that China has a different political system. The key is the extent to which the private sector is allowed to flourish. And here, the news has improved over the past year. We have become more optimistic recently. Since last autumn, policymakers have been far more willing to support enterprise. It started with measures to backstop the real-estate sector, which has been a major drag on activity. Then the central bank allowed firms to borrow cheaply to buy back their undervalued stocks, accelerating a trend towards buybacks that companies had started themselves. That was a key turning point for us.

The state is also supporting developments in technology, with DeepSeek’s large language model being rapidly adopted in both the public and private sectors. The government hopes to harness AI’s potential to accelerate progress in areas where China is already leading, such as robotics, electric vehicles and cutting-edge biotechnology. The big picture is that the government used to favour particular industries, but now seems to be keen to bolster the entire private sector.

And this is very important. The main reason countries get stuck in the middle-income trap is a failure to innovate, not adverse demographics or other factors. This is clear to Beijing, which is why the leadership keeps on pushing to make their economy more productive, and keeps on pushing to be at the forefront of technological development in many industries. Beijing is also acutely aware that some sectors are oversupplied, with rampant competition rendering margins razor-thin. The banks have fuelled the boom in capital expenditure, and could now take measures to help sector leaders buy up less productive rivals and perhaps rein in lending to struggling mediocrities. The least productive companies should gradually fall by the wayside. These measures are meant to address fears over the Japan-style zombiefication of the economy.

Andrew Van Sickle: Very encouraging. Taiwan is still the second-biggest weighting in the MSCI EM index. That’s due to chip giant TSMC, isn’t it? It’s the AI story.

Gustavo Medeiros: It has the tightest grip on the sector thanks to its ability to produce cutting-edge chips economically, with cutting-edge equipment. It would take years and a vast amount of capital for another company to emulate them, so that provides the company with an enduring competitive advantage; a deep “moat”. While Google could face a threat in search and Apple would struggle if another firm comes up with a gadget that is better integrated with AI than Apple’s range, I don’t see TSMC’s lead being eroded anytime soon.

Andrew Van Sickle: Let’s look at India, which you have described as the most exciting structural-growth story in EMs.

Gustavo Medeiros: No exciting structural story goes in a straight line, and there are now some wrinkles in the case of India. Around 18 months ago, valuations became extremely overpriced, which has been a headwind. And the pace of growth in capital expenditure, having surged in prime minister Narendra Modi’s first term as investment in infrastructure galvanised investment in the private sector, has ebbed.

A bright spot at present is the banking sector. Valuations are reasonable, private banks have done well with the adoption of fintech and have been able to deliver strong growth. Meanwhile, inflation is under control and short-term interest rates have been cut. The interest-rate curve is thus steepening, which is good news for banks’ net-interest margins. President Donald Trump’s tariffs are another headwind for now, although the economy is relatively insulated from global trade, given the large consumer sector.

The long-term outlook is still favourable, however, given the demographics, the dynamic private sector (the service sector will be able to exploit AI) and the gradual evolution of a manufacturing sector in recent years. Apple, for example, have said they will make all iPhones sold in the US in India by 2030.

Andrew Van Sickle: Finally, you have described Indonesia as a structural-reform story trading at crisis-level valuations.

Gustavo Medeiros: A year ago, power was transferred to president Prabowo. He is market reform-orientated, like his predecessor Jokowi, but investors appear to have been spooked by two policies. One was free school meals. This is sensible, but it took up a large share of the budget in a traditionally low-tax, small-government economy.

Then he consolidated state-owned companies into a sovereign wealth fund in order to gather their dividends together and allocate the money to the economy more effectively. Again, sensible enough, but investors were nervous because of the recent scandal surrounding Malaysia’s 1MDB sovereign wealth fund. Just as investors were starting to digest the uncertainties, the protests on the streets of Jakarta led to the exit of experienced finance minister Sri Mulyani. She was seen as one of the safest pair of hands across EMs, so even though her successor is likely to keep her policies unchanged, her exit was another blow to confidence.

Still, the broad pro-market direction is unchanged, and the long-term structural-growth story remains compelling. Indonesia has lots of metals that will be crucial to the global energy transition, while demographics are also a tailwind.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

Whatever else happens this year, Robin Zeng can claim one pivotal moment. In May, he took the contrarian bet of pushing ahead with a secondary listing of CATL in Hong Kong. It proved transformative, says the Financial Times. Shares in the company, a pioneer in batteries for electric vehicles (EVs), surged, lifting its market value to roughly $166 billion in the world’s biggest IPO of the year.

The float jump-started the wider market out of its post-Liberation Day slump, with the Hang Seng index now up 30% in the year to date. Leading the rally in confidence, amid new optimism about a trade détente between the two superpowers, is China’s battery king – now a Hong Kong citizen and vying with business magnate Li Ka-shing for the title of Hong Kong’s richest person, with a net worth of some $40 billion.

Not that he apparently cares, says The Wall Street Journal. Zeng might have built CATL into a global juggernaut – its batteries were installed in one in three EVs globally last year – but he represents a new kind of tycoon flourishing in Xi Jinping’s China: understated, philanthropic and ready to echo official state talking points. “I don’t want to be the rich guy,” he observed on the eve of the float. “I want to share these riches to create a good society.”

Zeng, 57, emerged during a turbulent period for tech executives and has learned the lessons – leveraging his know-how “and the state’s willingness to throw money at the renewable energy and EV industries” while keeping his head down. He toes the line on Xi’s vision for China, “where ostentatious displays of wealth aren’t tolerated and humility is the sentiment of the day”. His draws inspiration from the early Chinese sage Confucius, with his “lifelong learning and continuous moral improvement”.

How Robin Zeng made his money

Born in 1968 as Zeng Yuqun, he grew up in poverty in a mountain village in the southeastern province of Fujian – near Ningde, where CATL is now based. “A strong student with big ambitions”, Zeng won a place at the prestigious Shanghai Jiaotong University. He quit his first job at a state-owned enterprise in Fujian after just three months and moved to Dongguan to join an electronics manufacturer, studying part-time for a PhD in physics at the Chinese Academy of Sciences. In 1999, he started his own company, Amperex Technology (ATL), producing lithium-ion batteries. Apple was an early customer. Zeng realised his first fortune in 2005, when he sold ATL to Japan’s TDK for $100 million, says The Wall Street Journal. But he “stuck around”, setting up a car-battery division. TDK was banned from the Chinese market because it was a foreign company, so Zeng started CATL in 2011.

“The timing was perfect” – Beijing had begun prioritising EVs and was offering generous subsidies. As with ATL, Zeng built the firm’s reputation on a contract with a blue-chip Western brand, BMW. A big boost came in 2015 when Beijing told global automakers they would only qualify for subsidies if they used batteries from approved Chinese suppliers, including CATL. Within a year, revenues rose from $1.2 billion to $9 billion.

Zeng sees himself as much more than a battery-maker, says the FT. His ambition for CATL is to become “the pioneer” of the broader zero-carbon economy. He’s particularly interested in lowering the energy costs of vertical farming, telling Bloomberg that “if you solve agriculture, then you’ve solved everything”. Yet CATL remains at the mercy of politics. In January, the US added the firm to a blacklist of companies with alleged links to the Chinese military (a claim denied by CATL). That threat might have receded, but it hasn’t gone away. Moreover, entrepreneurs like Zeng are at the whim of Xi, says Desmond Shum, the Hong Kong businessman who wrote Red Roulette. “If you don’t understand this, you’ll be the first one slaughtered.”

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

Is China already ahead on tech?

It’s there or thereabouts. A technology index by researchers at Harvard, published last month, ranked 25 countries across five sectors: artificial intelligence (AI), semiconductors, biotechnology, space and quantum technology. It placed the US first in all categories, but with China breathing down its neck in second. By contrast, a recent study by the Australian Strategic Policy Institute found that China has already pushed ahead decisively in crucial areas. The think tank found that, back in 2003-2007, the US led China in 60 of 64 frontier technologies – such as AI and cryptography – while China led the US in just three. By 2019-2023, the position had reversed. China now leads in 57 of 64 key technologies, and the US leads in only seven.

Where does China excel?

The world’s largest and most innovative producers of electric vehicles (BYD), EV batteries (CATL), drones (DJI) and solar wafers (LONGi) are all Chinese start-ups, none more than 30 years old. Chinese firms are competing aggressively in other innovative sectors in which the US has long been dominant: aviation, telecoms, robotics, nuclear power and fusion research, quantum computing, biotech and pharma, and solar energy. For now, the US and its allies (including Taiwan) maintain a narrow lead in advanced microchips and AI, says Christopher Mims in The Wall Street Journal – but the gap is closing faster than ever. China’s domestic chipmaking network still lags, but the idea that it is far behind, or will remain so, “flies in the face of history”, says industry analyst Patrick Moorhead. It’s only a matter of time, he argues, before China will be in a position to source everything it needs in order to match or exceed the capabilities of firms such as Taiwan’s TSMC and the US’s Intel.

What about AI?

The “DeepSeek moment” in January, when the Chinese company unveiled a large language model (LLM) almost matching the capabilities of OpenAI’s ChatGPT, but for a fraction of the investment, confirmed that China is “snapping at the heels” of the US, says The Economist. It was a startling moment, but obscures the fact that China’s policymakers are making a different kind of strategic race, focusing on practical applications of AI in factories and for consumers. US firms focus on the model, but Chinese players emphasise practically applying AI, says Zhang Yaqin, a former boss of Baidu, now at Tsinghua University – the same pattern by which China stole a lead in e-commerce and e-payments. At the same time, China is lavishing state support on the entire AI tech sector, in chips and data centres and energy, says Kyle Chan of the RAND Corporation.

What is China doing right?

China has advantages that previous challengers to US hegemony do not. It has a huge domestic market, so it can incubate firms within its borders before they go global. Although it remains dependent on the US and other nations for many raw materials and specialised goods, it has a decades-long strategy of pursuing self-sufficiency in high-tech sectors. That means it’s producing an ever greater slice of all it needs. Education is another example of long-term commitment to strategy and execution, says Lee Jong-Wha on Project Syndicate. Superior higher education is a proven driver of success in the struggle for global economic, technological and geopolitical leadership. China has invested in building world-class universities such as Zhejiang University, modelled on Stanford, which has helped transform Hangzhou into a Chinese Silicon Valley.

The US, by contrast, is “actively undermining its elite institutions of higher education – not least by alienating foreign talent”. The current administration’s policies (suing colleges over ideological misdemeanours and discouraging foreign students) are spectacularly misconceived. Many of the world’s most valuable firms, including Google, Meta, Nvidia, and Tesla, were built by graduates of elite US universities, and many were not American. Over half of the US billion-dollar start-ups have at least one immigrant founder, and a quarter were launched by individuals who first arrived in the US as international students.

What should the US do?

Most fundamentally, say David Autor and Gordon Hanson in The New York Times, US policymakers need to stop looking in the rear-view mirror and start focusing on the road ahead. The US still frames its strategic competition with Beijing with reference to the first “China Shock” of 1999-2007, when China’s transition to a market economy helped erase nearly a quarter of all US manufacturing jobs. But that’s history, and the US now risks fighting the last war. What’s coming now is “China Shock 2.0”, and it will be far more profound and long-lasting. The original, manufacturing shock ebbed as China ran out of low-cost labour; “China Shock 2.0 will last for as long as China has the resources, patience and discipline to compete fiercely.”

How should the US respond?

The best response to that threat is for the US to act in unison with commercial allies such as the EU, Japan, Canada, the UK, Australia and South Korea, say Autor and Hanson. At the same time, Chinese firms should be encouraged to set up production facilities in the US and elsewhere. That sounds counter-intuitive, but it’s similar to the way China once encouraged Western companies to do the same in China as a way of speeding up technology transfer. Chinese policymakers refer to this as the “catfish effect”, whereby a strong foreign competitor spurs the weak domestic “sardines” to swim faster or else get eaten. In addition, the US should follow China in “aggressively promoting experimentation in new fields”, as happened in the US and Europe during World War II. Finally, the US needs to “choose the battles” it can win (semiconductors), or those it cannot afford to lose (rare earths) and make the long-term investments to reach the right outcome.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

If Xi Jinping wrote a book about dealing with Donald Trump, it would probably focus on “exploiting the US president’s greatest weaknesses” – and then “using the time gained” to strengthen China’s position, says The New York Times. “The Art of the Stall” appears to have been Beijing’s strategy. Rather than yield to tariff threats, China played the “trump card” of its control of critical minerals, while kicking thornier disputes deep into the long grass of “framework” talks. As an exercise in cunning, it cannot be faulted.

The irony, says The Spectator, is that even as Xi basks in the admiration of Western strategists, his position at home is looking ever less secure. Two years ago, the dictatorial Communist Party leader “presumptuously declared his intention to rule until 2032”. Plenty of people are now prepared to bet against that outcome. Reading the runes of what is going on in the opaque world of Chinese politics is always difficult, but of late, China-watchers have “detected subtle changes”.

In the last two weeks of May, Xi seemingly disappeared from public view – and his once ubiquitous presence on the front cover of the “People’s Liberation Army Daily” has become much patchier. His power base also appears under threat. Prominent members of Xi’s “Fujian faction” – including the vice-chair of the Central Military Commission and a senior admiral – have been arrested or investigated, while “other Xi generals have been removed from their posts”. A 40-episode drama series, Time in the Northwest, was dropped by China’s main state broadcaster after just two episodes. The piece was “an unashamed glorification” of Xi’s family – in particular his father, Xi Zhongxun. A revolutionary who rose to power under Mao before being purged in the Cultural Revolution, he was rehabilitated under the reformist Deng Xiaoping in the late 1970s.

Unshakeable loyalty

Few people have shaped Xi, who was born in 1953, as much as his father, says The Economist. Which is why a new biography of Xi Zhongxun by the American scholar Joseph Torigian conveys such fascinating, and sometimes gruesome, insights. In The Party’s Interests Come First, Torigian shows that, throughout his life, “Xi has been loyal to two groups that demand absolute obedience: the party and the family”. Both were often strict, yet that never dented his loyalty. As a boy, Xi washed in his father’s bathwater and practised deference at every turn, having been taught that “children who did not respect their parents were doomed to fail as adults”. Even when Xi was in his mid-30s and a rising star in the party, the ordeals continued. Torigian relates how Xi Zhongxun – then in his 70s with rotten teeth – “extracted some half-masticated garlic ribs from his mouth and gave them to his son to finish”. Xi accepted “without hesitation or complaint”.

After the hardships the family had endured during the Cultural Revolution, this probably seemed tame. When Xi Zhongxun was kidnapped, held in solitary confinement and tortured, his family was forced to denounce him. One daughter committed suicide, while the teenaged Xi was branded a traitor and forced to wear a heavy steel cap in front of a baying crowd. “His mother joined in the jeering.” Shortly after, Xi was “sent down” to a desolate part of the country, where he lived in a cave.

Xi’s rise began when his father became governor of Guangdong province, a “Special Economic Zone”, under Deng. But expectations that he would become an economic reformer proved premature. “His experience of injustice has not taught him that arbitrary power is undesirable; only that it should be wielded less chaotically than it was under Mao, by someone wise like himself,” says The Economist.

Might his time be up? Similar rumours have circulated before and come to nothing, says The Spectator. But given “the dire problems facing China” and the “indifferent performance” of its autocratic leader, it’s quite plausible that “CCP elders are casting around” for a more liberal successor. “If so, the consequences for Taiwan, and US-China relations, could be dramatic – and possibly beneficial to both.”

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

There is one very odd fact about commercial aviation. Although it has grown hugely, and we all fly far more frequently than ever before, it has hardly advanced technologically for 60 years. Sure, the aeroplanes are a little safer, slightly quieter, and they use less fuel, but those are all minor modifications. In the one respect that matters to passengers – how quickly you can get to your destination – it has gone backwards. You can no longer fly faster than the speed of sound, as you could when Concorde was still operational.

That might be about to change. We are on the cusp of a new era of aeroplane travel, with a whole series of technological advances making it possible that a commercial supersonic jet might be back on the market soon.

The trouble is, China may get there first. Its hyper-aggressive aeroplane maker Comac has unveiled plans for a supersonic passenger jet, the C949. It has already launched the C919, a competitor to the Boeing 737 and the Airbus A320 family, and it has plans for a C929 competing with the Boeing 787 and the A330. It’s now started work on the C949, a supersonic aircraft that it claims will be able to travel at 1.6 Mach.

It would be easy to dismiss that as marketing hype. But consider China’s advance in EVs, smartphones and AI. Its commercial science and engineering is far more advanced than most people have yet realised. It’s perfectly capable of making a quality jet that can travel that fast, and do so safely. It may well do so before any of the major Western aerospace firms.

Yet the West can’t afford to lose this race. A cheap, reliable and quiet supersonic aeroplane could easily turn into a “killer app” to knock out Boeing and Airbus. After all, if they were offered the choice, and so long as there was not much difference in price, who wouldn’t want to get from London to New York in three hours instead of six, or from Paris to Shanghai in six hours instead of 12? Travel within most of the US, Europe and Asia would involve a connection of an hour or less; even Australia would be no more than a 12-hour, non-stop flight from anywhere. It would transform the industry.

The West must accelerate innovation in commercial aviation

If China gets there first, it will create a huge new hi-tech manufacturing industry. It will generate lots of jobs, just as it does in North America and Europe, a network of well-paid suppliers, and plenty of spinoff start-ups. With a jet that’s faster than sound, China could leapfrog both its main rivals in a little more than a few years. Just as significantly, it could lock the world into a critical infrastructure controlled by Beijing.

Both the US and Europe should be spending a lot less time bashing China with tariffs and more time working out how to maintain European and US leadership in core industries. If China is close to developing a commercially viable supersonic passenger jet, then perhaps there should be a Boeing-Airbus joint venture to get their own aeroplane onto the market at the same time, or preferably before the Comac version takes to the skies; or a government-funded collaboration on the core technology, which could then be licensed to both companies to build their own jets; or an entirely new firm to build a new generation of aeroplanes.

There are a range of approaches that could work. But the West can’t afford to lose this race. Commercial aviation is one of the few industries left where the US and Europe are clearly dominant. Travel that’s faster than speed could easily turn the entire industry upside down. Right now, the West is doing nothing to stop that from happening.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

There’s no question that Chinese stocks have been a huge disappointment for investors. Over the past decade, the MSCI China index – the standard benchmark for foreign investors – has delivered a gross total return of 3.9% per year in sterling terms, barely half the already-disappointing return for the MSCI Emerging Markets ex China.

It used to be easy enough to argue that the overall market was poor because of the large number of state-controlled firms with little concern for their minority shareholders, but there were still excellent opportunities in technology or consumer goods. Yet that has been a harder case to make lately, since many of the big private-sector names have been weak over the past five years.

Still, taken at face value the market now looks cheap: the MSCI China trades on ten times forecast earnings. Certainly that reflects the presence of many poor-quality companies, but a valuation this low redeems a lot of sins for investors willing to take the risks.

Two problems that floored Chinese stocks

And there is no shortage of risks. We can come up with a list of reasons to worry about China in the medium term. There’s demographics: the population is set to age faster than almost any other country. There’s geopolitics – its territorial interests may one day bring it into direct conflict with other powers such as the US, particularly its insistence that Beijing should one day rule Taiwan, regardless of the views of the Taiwanese people. These are real concerns for investors over the next decade.

That said, we can find reasons to be bearish about almost any country and these have little to do with how poorly the economy and the stockmarket have performed over the past few years. Instead, we can put the immediate problems down to two things.

The first is the bursting of the real-estate bubble. Property had become a huge proportion of GDP – about 25% including both direct and indirect demand – and a key source of growth. It had also become wildly over-supplied, over-valued and over-indebted. The biggest problem with the decision to bring it to an end by curbing lending to developers is that the tougher rules came far too late. Policymakers made the same mistake as Western governments in the 2000s of letting a real-estate bubble run for far too long, with the result that tackling the problem became even more painful.

The second is the crushing of “animal spirits” in the economy, through a series of other crackdowns on tech firms, finance and some smaller sectors. As with real estate, there were often solid arguments for the government to intervene. The giant tech firms had taken advantage of limited regulation and state influence (compared to many sectors of the economy) to build dominant positions and to try to extend this as widely as possible. There was a risk of ending up with entrenched monopolies that harmed consumers and smaller businesses.

The problem was that the crackdowns showed all the traits that worry investors most about China: very sudden changes to regulations, no certainty on where the limits would be, a lack of fundamental private property rights and rule of law, and unambiguous signs that private-sector firms would be squeezed in favour of state-owned enterprises, and increasingly co-opted into serving the priorities of the government rather than shareholders.

China's government must do more

No wonder that foreign investors became relentless sellers and talk of China being “uninvestable” was common. The sluggish performance of the A share markets – stocks listed in Shanghai and Shenzhen – showed that domestic investors were becoming increasingly pessimistic as well.

However, last year there were some signs that the government has pivoted and is becoming more pro-growth and even a bit more pro-business. There have been some moves to boost consumption, support the real-estate sector and provide more financing for local governments. This led to a pop in Chinese shares in September, but the gains have not been sustained. Investors feel the government hasn’t done enough to turn around the economy and that it needs to do more, especially in real estate. The widespread consensus is that the property sector is so influential there is no way to get growth going again without stabilising it in the short term. There is also a fair amount of optimism that the government will do more. If it does, China is so unloved there is a lot of potential for markets to rally.

There are three trusts in the China specialist sector. While they share many major holdings, they also feel distinctively different, which is helpful for investors. All trade on similar discounts of 10%-11% at present, so the decision is really down to strategy.

The largest by far is Fidelity China Special Situations (LSE: FCSS) at £1.6 billion in assets, which last year merged with Abrdn China. One would not call this a value fund, but relative to the others it has a tilt to value and to mid-cap and small-cap stocks. It has the best return of the three over most recent periods, despite carrying the most gearing (23% now) in a tough market.

Next, at £225 million, there’s JPMorgan China Growth and Income (LSE: JCGI). This targets an annual dividend of 4% NAV, paid quarterly, but it doesn’t specifically invest for income – the portfolio has a growth tilt. So some of the payout will come from capital, as is increasingly common with higher-yielding trusts.

Lastly, Baillie Gifford China Growth (LSE: BGCG), with £160 million, is focused on growth stocks in sectors such as tech. This is the former Witan Pacific trust, which was turned over to Baillie Gifford with a new single-country focus in October 2020. The timing of this was not ideal given the crackdowns, and it has fallen a long way since (although better than JCGI). However, if the outlook is genuinely changing, its approach could be a beneficiary.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

Last year was a “relatively quiet if depressing” one for China, says James Palmer in Foreign Policy. This year could be “a lot stormier”, especially when it comes to relations with the US. With Donald Trump about to start a second term as US president and threatening to saddle China with tariffs of 60%, the “leadership in Beijing is readying for a ferocious economic struggle”.

It is not in a good place for a trade war, says William Pesek in Nikkei Asia. Although China under Xi Jinping has made progress in transitioning from cheap exports to higher-value sectors, Xi has “slowed things down by prioritising control over change”. Cracks in the economy include manufacturing overcapacity, the ongoing property crisis, “shaky” local government finances which are hindering investment, record unemployment and falling confidence.

Xi Jinping's three-pronged US strategy

China has plenty of leverage – the US imports roughly $430 billion annually from China and exports close to $150 billion – and it is sending a clear signal that it is ready to strike back, says Alexandra Stevenson in The New York Times.

On 2 January, China added 28 American firms to an export control list. It has also announced an antitrust probe into Nvidia and banned the export of rare minerals to the US.

Xi’s planned three-pronged US strategy – “retaliation, adaptation and diversification” – is defined by “clarity and determination”, adds Evan Medeiros in the Financial Times. Though the effects have been patchy, “vigorous fiscal and monetary stimulus to help businesses and now consumers” began in late 2023 with a “possible trade war in mind”. Beijing is considering unilateral tariff cuts on imports from non-US partners. Nevertheless, China’s economic crisis hasn’t changed Xi’s “commitment to a directed economy and officials’ unwillingness to tell him no”, says Palmer. He has reportedly said that he “doesn’t see what’s so bad about deflation”. If Trump’s tariffs don’t lead to a “rethink”, they could ironically help Xi by providing a “convenient scapegoat” for public anger.

This stand-off couldn’t come at a worse time, says Thomas Friedman in The New York Times. The world faces “three epochal challenges” – “runaway artificial intelligence, climate change and spreading disorder from collapsing states”. The US and China are the world’s two AI superpowers, two leading carbon emitters and have the two largest navies – in other words, they are the only powers that offer any hope of addressing these challenges. We need an “updated Shanghai Communiqué” (the Nixon-Zedong era document which set out the principles for the normalisation of US-China relations).

That would help govern the new realities and ensure that AI cannot be “used for destructive purposes by bad actors”. Strategies to get the world to net zero by 2050 are also needed to reduce the effects of climate change, which will increase disorder in failing states, an issue that constitutes a “big common enemy”. From Syria to Venezuela, “more and more nation-states are falling apart” with migrants “scrambling to get to zones of order”. “If competition and collaboration give way entirely to confrontation, a disorderly 21st century awaits.”

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

China has announced a ¥10trn (£1.08 trillion) stimulus package, but investors are “disappointed”, say Samuel Shen and Tom Westbrook on Reuters. Since September, Beijing has unveiled interest-rate cuts and an “unprecedented” ¥800 billion stock market rescue package.

The CSI 300 share index jumped 25% but has lost momentum in recent weeks as markets have awaited more details on stimulus plans. The new ¥10 trillion package addresses local government debt, but included “no measures to facilitate bank recapitalisation and/or boost consumption”, Nomura analysts tell the Financial Times. The emphasis is on “stabilisation rather than stimulus”.

China needs to tackle hidden debt

China’s central government has relatively low debt levels, but the same cannot be said for provincial administrations, say Meaghan Tobin and John Liu in The New York Times. Local governments have borrowed heavily for years to finance infrastructure projects and hit official growth targets.

Covid didn’t help – debt levels in many provinces doubled from 2018 to 2023. Local officials got around borrowing limits by using off-balance sheet “local government financing vehicles” (LGFVs). LGFVs are “quasi-commercial infrastructure firms” that enjoy state backing, says The Economist. LGFV's debt is thought to have been $8.6 trillion by late 2022. The new stimulus will allow local governments to refinance these debts at a lower interest rate, yielding ¥600 billion (£65 billion) in savings over five years. But that amounts to “less than 0.1% of China’s expected GDP” over the period.

Total central and local Chinese state debt is just over 50% of GDP, says Jacky Wong in The Wall Street Journal. But add in LGFVs, and public debt “has risen from 73% in 2019 to 102%”, according to Morgan Stanley estimates. China’s local governments are “responsible for the bulk of public spending from infrastructure to education” but they “lack reliable revenue sources to match”. They used to rely on land sales to make ends meet, but a sluggish housing market has slashed that income.

With Donald Trump vowing to impose 60% tariffs on China, investors think further stimulus could be coming. Goldman Sachs thinks a 60% tariff could cut Chinese GDP by 2%, compared with a 0.65% hit from the 2018 trade war.

There is a “mismatch” between investors’ expectations and Beijing’s priorities, warns Nicholas Spiro in the South China Morning Post. Markets think Trump’s tariffs, which will hit Chinese exporters, will force officials to stimulate domestic consumption to compensate. But the government does not want to overheat the economy or send debt levels soaring again. As Robin Brooks of the Brookings Institution puts it: “China has only one option in response to tariffs: allow the [yuan] to fall hard and fast... Markets should stop chasing China stimulus.”

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

Forget the Budget. Forget the US presidential election. In the end, neither will make much difference to companies or to investors one way or the other. Something far more significant is happening, even if few are paying much attention to it. A new wave of Chinese consumer brands is starting to push out into global markets.

The coffee market might already look hyper-competitive, but it is about to get a lot more crowded. Last week, China’s largest chain, Luckin Coffee, said it was planning to launch in the US market next year. It has already started advertising during sports events and has built up a list of initial locations in cities with lots of Chinese students and expats. It plans to undercut the big US chains by selling coffee in the $2-$3 price range, instead of the $5-plus for the big cups that have become the norm at Starbucks and many of its rivals.

As the younger, more prosperous Chinese switch from tea to coffee, Luckin has steadily turned into a huge business, with more than 20,000 outlets, far more than the 7,000 Starbucks has in China, and closing in on the 38,000 it has globally. It is profitable and growing quickly, while Starbucks has stumbled from crisis to crisis, switching one chief executive for another, and redrafting turnaround plans, even while the share price struggles. Luckin may well be pushing at an open door, with lots of money to spend, and a pitch to customers who are looking for something different.

Likewise, in the electric-vehicle industry, emerging Chinese colossus BYD last week overtook Tesla, recording higher revenues in the third quarter than the US market leader. The US and the EU may be slapping punitive tariffs on Chinese electric cars, but so far that has not slowed down their rise. With Tesla surpassed, Volkswagen and Ford may well be next in line as customers find the Chinese-made vehicles are often better than Western models, and certainly a lot cheaper. Chinese fast-fashion brand Shein has also expanded globally, and plane manufacturer Comac is ramping up production and could soon be as familiar as Boeing and Airbus. China’s home-grown brands have been building and growing over the last two decades and are now ready to expand into the global market.

Complacent Western giants are not nearly ready for them. Starbucks, as noted, is in crisis. Our car companies are dependent on subsidies for their electric vehicles and are relying on their governments putting punitive sanctions on their Chinese rivals. Boeing and Airbus have allowed quality issues and delivery delays to undermine their reputations as if the industry was still a cosy duopoly. The list of industries where China poses a real threat is likely to get longer over the next few years.

Why are Chinese consumer brands so popular?

China’s emerging brands have two things on their side. First, a vast domestic market, with more than 1.4 billion people, and 145 cities with more than a million people, mostly speaking the same language, and all using the same currency and the same payment systems. It is a strong base and one that can be used to fund expansion overseas. Next, and perhaps more importantly, many of them have developed their own distinct offering. The coffee chains have far more sophisticated apps than their Western rivals. The car companies have lower costs and often better design and technology. Western multinationals often still think of China as a country where they can offshore manufacturing. They are ignoring that it has grown richer and is bubbling with fresh ideas, some of which will be very successful.

The overall Chinese economy might be slowing down, but that should not fool anyone that the competition from Chinese companies is about to disappear. Even without any further growth, China is still the second-largest economy in the world and it has turned into a thriving laboratory for new entrepreneurial ideas. Investors spend a lot of time fretting about interest rates, tariffs, employment and all the other things that impact corporate profits. They are blind to the challenge to Western consumer brands from Chinese rivals. The fight has only just begun.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

Excitement over a Chinese stimulus “bazooka” is starting to wane, say Wataru Suzuki and Stella Yifan Xie for Nikkei Asia. Beijing has unveiled a series of stimulus measures designed to reinvigorate the world’s second biggest economy, sending the local CSI 300 index soaring by more than a fifth. Markets have been pinning their hopes on a rumoured ¥1 trillion-¥3 trillion (£107 billion-£322 billion) in “fresh fiscal spending”, but details are lacking.

Finance minister Lan Fo’an merely said there is “relatively large room” for new state borrowing. Fo'an plans to use it to help cash-strapped local governments and to stabilise the property market, says Keith Bradsher in The New York Times. Investors want numbers, but for that, they must wait until later this month, when the standing committee of the national legislature is expected to “sign off” on new debt issuance.

How are investors reacting to the Bazooka stimulus? 

Markets are hoping for a bazooka stimulus to rival China’s massive response to the 2008 global financial crisis, says Mohamed El-Erian on Bloomberg. They are likely to be “disappointed”. Not for the first time, foreign money managers are “grossly” oversimplifying the Chinese economy. Officials have always shown a preference for “limited stimulus”. They are well aware that a huge fiscal bazooka would only exacerbate the “serious imbalances” and debt that caused this slowdown in the first place. China wants an “insurance policy” against a serious economic crunch, not a bazooka that will fire up another unsustainable boom.

The stock market rally is part of a strategy designed to raise economic confidence, says Ambrose Evans-Pritchard in The Telegraph. These state-sanctioned “boomlets” usually run for two months before regulators step in to cool things down. That said, with global interest rates falling, the current rally may have a little more “staying power”. Stocks “could have a pop for a while, but the risk is what we saw coming out of Covid”, says Bill Bishop of the China Sinocism newsletter. “There was quite a rally for a couple of months but then people realised that the economic policies hadn’t changed.” On 11 times forward earnings, Chinese shares are temptingly undervalued, says Chan Ka Sing for Breakingviews.

The equivalent rating for Indian shares is 20. But the Shanghai market trades heavily on sentiment – much of this rally “has been fuelled by fast money betting” on the latest government announcements. “Chinese stocks have become more of a trade than a long-term investment.” The market’s long-term record is disappointing, agrees Buttonwood in The Economist. Over the past 15 years, Chinese GDP has “quadrupled” in nominal terms, yet the CSI 300 is up “less than a quarter” over the same period. Should long-term “buy and hold” investors pile in? “The answer is clearly still ‘no’.”

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

It’s often claimed that China’s leaders take a long view, unlike the short-term thinking that prevails in Western economies. Looking at the markets, we might doubt how well that’s working. Late last month, the government abruptly unveiled a series of schemes aimed at supporting consumption and housing, bailing out indebted local governments and banks, and boosting stocks. The CSI 300 index rallied 32% in two weeks, then fell 7% – the biggest one-day drop since 2020 – when some details didn’t meet expectations.

Pessimists may see this as part of a pattern that’s been evident in China over the last few years: exceedingly rapid pivots that keep wrong-footing markets and leave them struggling for long-term direction. Take, for example, the sudden reopening from zero-Covid policies in early 2023, after giving every sign that progress would be very slow. Or the abrupt crackdowns on various sectors from education (virtually overnight) to tech (more telegraphed, but also longer and more severe than expected) to property (understandable and overdue, but the full consequences seemingly weren’t appreciated). In general, the consistency of policymaking has become much worse over the past few years. It’s worth keeping that in mind when considering whether this is a turning point.

Will structural reforms fix China's consumption?

Let’s start from the widely acknowledged position that consumption is too weak in China. The government can try to boost short-term growth. It can even target this carefully: by handing out stimulus payments as vouchers, money will flow to local restaurants or Chinese-made white goods, rather than European luxury goods. There is also a strong case for the central government to use its balance sheet to back more fiscal spending. One long-standing problem is that Beijing expects cash-strapped local governments to shoulder the burden. Local governments typically depend on selling land for property development for much of their revenue and are thus exceptionally poorly placed to respond in a property downturn.

Yet until China fixes the structural problems that keep consumption as a relatively low share of the economy, this can only amount to a short-term boost. While that may well be helpful to get the economy out of its current slump, it would be even more encouraging to see faster progress on difficult issues such as the hukou system (household residency permits, which worsen the gap between the wealth of urban and rural residents), social security and land rights, all of which could unlock more consumption from poorer households.

On the plus side, Chinese stocks still do not look expensive. The MSCI China index – mostly stocks listed in Hong Kong – is on a p/e of 11, although the MSCI China A – Shanghai and Shenzhen-listed shares – is a bit higher at 13.5. If growth picks up, this rally could run, even without reforms. There are plenty of cheap tracker funds to follow it, while trusts such as Fidelity China Special Situations (LSE: FCSS), JPMorgan China Growth and Income (LSE: JCGI) and the tech-focused Baillie Gifford China Growth (LSE: BGCG) are on discounts of 10%-15%.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

“China’s real-estate collapse may be morphing into something much larger: a deflationary economic bust,” writes investment strategist Ed Yardeni. “Buying a home was one of the primary ways that Chinese citizens used to invest and build wealth but new home prices have fallen by 5% year on year, marking the 13th month of consecutive declines. So the housing bust has taken a toll on Chinese consumers’ confidence, now at near-record low.”

According to the People’s Bank of China, 96% of residents own a home and 20% own more than one, yet the population is ageing rapidly, reducing demand and hence construction activity. Average house prices soared from £321 per square metre in 2005 to £737 in 2020, leading to a housing price-to-income ratio of 29. As a result, household consumption accounts for just 37% of GDP, compared with 68% in the US, according to economist Diana Choyleva. “More spending is crucial to revive China’s flagging performance.”

While households respond to falling property prices by increasing savings, the response of the government is to stimulate industrial production, rather than consumption, says Yardeni. So output rose 5.1% year on year in July, while retail sales growth of just 2.2% was far below the 10% achieved historically. With money supply now contracting for the first time this century, “Chinese nominal GDP growth could turn negative over the next six months”, says Yardeni.

Is China being overlooked by investors?

Against this economic background, it’s not surprising that ten-year government bond yields have plunged to 2.2% and that stock prices, especially for property shares, are on a downtrend, having fallen over 40% in four years. Most Asian fund managers are cautious; Schroder Asian Total Return trust is “significantly underweight” with an allocation of 15% to China (including Hong Kong) compared with 33% in its benchmark index.

Invesco Asia Trust takes a contrarian view. Managers Fiona Yang and Ian Hargreaves are overweight China. “Green shoots in China are being overlooked [with] abundant household savings, solid balance sheets and supportive policy announcements recently,” they say. “Should attitudes towards China start to improve, they will be doing so from a low starting point, with deeply discounted equity valuations likely to be very sensitive to signs that corporate fundamentals are starting to improve.”

Invesco Asia has £240 million of net assets while its shares trade at an 11% discount to net asset value (NAV) and yield 4.3%. Performance in the last year has been flat, thanks to its caution about booming India and prematurely favouring China, but the shares have returned a respectable 36% over five years. 

“IAT’s contrarian approach means investors are likely to get a differentiated portfolio to what is available elsewhere while the contrarian approach has been successful over the longer term,” says Kepler, a broker.

Ongoing geopolitical tensions

“Geopolitical tensions linger,” admit Yang and Hargreaves, but China appears to prefer bullying and threatening Taiwan to the risk of an actual invasion. Whoever wins the US election, tension between America and China is likely to continue. 

“At its core, the US-China rivalry is a clash of ideologies,” says Choyleva, “with America seeking to create a united front against China’s expanding reach and to confront its economic practices,” such as its predatory industrial policy and intellectual property theft. 

Perhaps China is just following the doctrine first espoused by UK prime minister Lord Palmerston nearly 200 years ago: “We have no eternal allies and we have no permanent enemies. Our interests are eternal and permanent, and those interests it is our duty to defend.” If economic adversity is mellowing China’s confrontational approach, Invesco’s strategy could pay off handsomely.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

The world’s capitalists are feeling cheerful, says John Authers on Bloomberg. Why? Because the “politburo of the world’s largest communist state” is warming to the idea of more welfare spending. There are “enough ironies… to sink the Titanic”. Chinese stocks leapt 8.5% on 30 September for their best day since 2008. Over five sessions the CSI 300 index has risen an astounding 24%. In Europe, luxury shares, which are highly exposed to Chinese consumption, also rallied strongly.

Why are Chinese stocks rising?

The excitement came after a statement by the politburo suggesting Beijing is open to using fiscal stimulus to “prod consumers to start buying stuff again”, something economists have been advising for years to little effect. Stronger social support policies are also on the table. There are as yet “no numbers”, but the declaration of intent from political leaders has been enough to trigger a surge of confidence in stock markets.

“Gone is the equivocation on deleveraging, moral hazard and provincial indebtedness, a staple of previous politburo meetings,” says Marko Papic of BCA Research. “This is Beijing’s ‘Whatever It Takes’ moment,” he says, a reference to Mario Draghi’s famous declaration in 2012 during the euro crisis. Investors are dreaming of a repeat of China’s “massive” 2008 stimulus, which helped the country avoid the worst of the global downturn, says James Mackintosh in The Wall Street Journal. But that splurge also left the economy with many of its current problems, including local government debt, overcapacity and excess housing.

China’s central bank had earlier unveiled a series of measures designed to tackle the housing slump, including easier monetary policy and cuts to mortgage rates for existing housing, says Anthony Anastasi for the South China Morning Post. But making credit cheaper doesn’t address the country’s fundamental “structural imbalance” – consumption is too low, while investment and savings are too high. High investment was a good strategy when China needed to build out its infrastructure and factories, but now all those factories are pumping out products that local households don’t have the cash to buy. What’s needed is a rebalancing towards consumption.

That is why the politburo’s hint of big fiscal stimulus to come has excited markets, says Reshma Kapadia in Barron’s. With the official 5% growth target “in jeopardy”, officials seem to have become “alarmed enough to shift out of slow gear”. For markets, the big question now is whether political statements are followed up with significant cash.

Some foreign investors are cautious, says the Financial Times. “We have seen these fits and starts, where China puts in place some kind of stimulus, and it has not resulted in a long-term constructive recovery,” says Saira Malik of asset manager Nuveen. “We’d be looking for more follow-through in terms of a pick-up in economic activity.” Others caution that a more immediate threat to the rally is coming into view: a possible Trump victory in the US presidential election and the prospect of a renewed US-China tariff war.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

Europe’s super-technocrat Mario Draghi – the former chief of the European Central Bank (ECB) and Italy’s emergency prime minister in 2021-2022 – delivered a long-awaited report into Europe’s stagnant economy on 9 September, and what can be done to revive it. During the eurozone’s sovereign debt crisis, the erstwhile World Bank and Goldman Sachs economist was famed for vowing to do “whatever it takes” to protect the euro from collapse. 

His mammoth and rather chilling 400-page report, delivered last week to the European Commission in Brussels, is “a great deal more wordy” but delivers essentially the same message, says the Financial Times. Draghi wants a far more integrated, bloc-wide industrial policy focused on digital and clean technology and defence, plus more rapid decision-making if it wants to keep pace economically with the US and China. In addition, it will need a gigantic level of public and private capital to raise the proportion of GDP spent on investment by 4.7 percentage points (about 27%). This time, “whatever it takes” works out at roughly €800 billion a year.

Is Draghi's report too ambitious? 

Just a bit. Relative to the size of the economy, the 4.7-point uplift is more than double the size of the Marshall Plan to reconstruct Europe from the ruins of the Second World War. Such a change would require a world-historic effort that has never been seen before and a radical overhaul of the EU’s political processes. But then the crisis, says Draghi, is genuinely existential: If Europe cannot halve the current “slow agony” of economic decline, it faces a much poorer and more unstable future and political irrelevance. 

“For the first time since the Cold War, we must genuinely fear for our self-preservation,” says Draghi, and “the reason for a unified response has never been so compelling”.

Are things really that bad in Europe? 

Perhaps the most sobering statistic in Draghi’s report, The Future of European Competitiveness, is a projection: the EU’s demographics (the familiar problem of an ageing population) mean that unless the bloc can improve its productivity growth, its economy will be no bigger in 2050 than it is today. 

But there’s no shortage of other contenders for Draghi’s most scary data point. In 1990, the EU’s 12 member states accounted for 26.5% of the global economy. Today, its 27 states account for just 16.1%. Since 2000, real disposable income per capita has risen almost twice as much in the US as it has in the EU. And European productivity is now just 80% of America’s, compared with 95% in 1995.

Euro-optimists could certainly point to the role of currency movements when it comes to GDP data. For example, the strength of the dollar since the global financial crisis (the euro traded above $1.50 in summer 2008, compared with $1.11 in mid-september) means there’s a risk of overstating the difference between the economies, when measured in dollar terms, since the comparisons don’t account for purchasing power parity. Moreover, some analysis suggests that America’s superior growth is more due to workers’ willingness to work longer hours and take less time off, rather than productivity per se (where some EU nations have in fact outperformed the US average in recent years). Nevertheless, even by its own analysis, Europe’s prospects are undeniably grim, and competitiveness is at the root of the problem. “We claim to favour innovation,” Draghi writes, “but we continue to add regulatory burdens on to European companies which are especially costly for small and medium-sized companies and self-defeating for those in the digital sectors”.

What are Draghi’s solutions and could they work?

The headline solution is massively greater investment to fund an industrial policy to allow the EU to compete with the US and China, especially in clean tech, digital and artificial intelligence. But there are 150 recommendations altogether, ranging across ten “strategic sectors”, with detailed proposals, including a reformed and more integrated single market, the creation of a genuine capital markets union, energy market reforms, looser merger rules and streamlined legislative processes making it harder for member states to slow down and veto changes. Draghi also urges reforms aimed at strengthening the bloc’s currently fragmented defence sector, so that industrial policy also serves geopolitical ends in a more threatening world.

If a “wand could be waved” and everything that Draghi proposes were implemented, “there’s no question it would put rocket boosters” under Europe’s economy, says Carlo Martuscelli in Politico. But the chances of this happening are close to nil. 

Germany’s finance minister immediately rejected the idea of joint debt issuance at the EU level, for example (sparking a political row within the already fragile coalition). And even if some of Draghi’s reforms are eventually pushed through, the process is likely to be typically slow, rancourous and convoluted – especially given that the EU’s normal motors, Germany and France, both currently have weak governments.

How did EU leaders respond to the report? 

This potentially landmark report should have been a “wake-up call”, says Iain Martin in The Times. The EU’s leaders didn’t quite “hit the snooze button” and go back to sleep, but nor have they exactly leapt out of bed with any energy or purpose. 

The sorry truth is that Draghi’s good ideas – the most vital one being a capital markets union – will get “kicked into the long grass of future budget negotiations” and the vast majority of them won’t happen. That’s bad news for the EU and bad news for the UK. We are part of Europe, and its security and defence – underwritten by a strong economy – are our problems, too. “Without some burst of visionary statecraft or a historical lucky break”, the future for Europe is one of decline.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

Related stories

• Eurozone’s stocks struggle
• Why Europe needs to spend big on defence
• ECB set to raise interest rates as stagflation beckons
• Will the euro crisis flare up again?

Chinese markets are stuck in “limbo”, say Abhishek Vishnoi and Winnie Hsu on Bloomberg. Fund managers complain the shares lack both “the vigour of an emerging market and the stability of a developed one”. The benchmark CSI 300 index is down more than 6% this year, leaving it on course for a fourth successive annual loss. Since a 2021 peak, roughly “$6.5 trillion has been wiped out from Chinese and Hong Kong” shares – the value of Japan’s entire stock market. 

While much of the world struggles with inflation, China has been battling the opposite problem, says Jacky Wong in The Wall Street Journal. On one measure, the GDP deflator (the gap between nominal and real GDP growth), the world’s second-largest economy has “already been in deflation for five straight quarters”. Falling prices can harm growth, with consumers holding off purchases for hope of cheaper deals ahead. 

How is China historically similar to Japan? 

Rather than UK-style furlough schemes, stimulus in China during Covid focused on infrastructure and building up new industries such as electric vehicles (EVs) and renewable energy. That might prove a wise long-term move, but the resulting “excess” manufacturing capacity cannot currently be absorbed domestically, triggering a surge in exports, which grew 8.7% in the year to August. 

Why is domestic demand so sluggish? Because local consumer confidence is not far off the historic low it reached in November 2022, says Ralph Jennings in the South China Morning Post. The root cause is a weak property market, say Nomura analysts, who estimate that prices of existing homes have dropped 30% from a 2021 high. When households feel poorer they spend less freely. And with corporate profits coming under pressure, “Chinese consumers have become more frugal”, since they “are worried about the prospects for wage growth and job security”. From “an overreliance on construction” to “a dependence on export markets” and “a rapidly ageing” population, China “shares many similarities” with the deflation-prone Japanese economy of the 1990s and 2000s, says Peter Hannam in The Guardian. 

Investors should remember that Japan’s Nikkei 225 took 35 years to regain its 1989 peak after the Japanese bubble burst. Comparisons with Japan are overstated, says Bloomberg News. China still has more scope for urbanisation and “catch-up” growth than Japan had in 1990, by which point the latter was already a high-income economy. A better parallel might be with South Korea. 

Following the 1997 Asian financial crisis, Korea seized new opportunities in semiconductors and smartphones. Similarly, China is now emerging as a leader in new green technologies and is already the world’s biggest EV market. Investors are on a global hunt for bargains, but China – where stocks trade on 11 times earnings – is conspicuous by its absence, says Katie Martin in the Financial Times. Whoever wins the US presidency, more tariffs look likely, jeopardising Beijing’s efforts to export its way out of trouble. “No one is interested in buying Chinese assets,” says Vincent Mortier of European asset giant Amundi. “I have never seen such a big pushback among all our clients.”

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

Most governments are desperate to lower their borrowing costs, says Jacky Wong in The Wall Street Journal. But in China, the authorities think markets are lending them too much money. Chinese banks have been piling into bonds, which causes their yields to fall. The country’s 10-year yields have dropped from 2.6% to roughly 2.18% over the past 12 months. 

Beijing wants to ward off a growing “speculative frenzy”. The “official explanation” is that banks that pile up bonds are exposing themselves to “huge losses” if rates turn – as America’s Silicon Valley Bank learned to its cost last year. Authorities have sought to cool markets by naming and shaming “a group of rural banks”, says Robin Harding in the Financial Times. Their “unusual sin”? Buying too many government bonds. It’s rather “like punishing a child for tidying their bedroom”.

Why are bonds looking attractive in Beijing? 

Yet the rush into government bonds is not a mere speculative bubble that needs to be popped. Rather, it is the “wholly rational” choice in an economy where the alternatives – stocks and property – have long disappointed. Bond markets are sending a signal that the economy is slowing and deflation is a growing threat. While Chinese price changes can be difficult to gauge, one measure – the GDP deflator – has fallen 0.7% over the past year amid sluggish domestic demand. Low or negative inflation increases the real return on bonds. Assets in Chinese bond mutual funds consequently soared 40% in the year to May, says Nicholas Spiro in the South China Morning Post. “Beijing might not like the bleak signal low bond yields are sending”, but “it cannot defy economic gravity”. 

Households and businesses are focused on paying down debt: “last month, bank loans shrank for the first time since July 2005”. Amid the longest period of deflation since 1999, policy circles are abuzz with comparisons to Japan’s prolonged slump in the 1990s. The root cause of sluggish consumption is not a mystery, says The Economist. In 2019, residential property accounted for 60% of the average Chinese city resident’s wealth. The property slump has “damaged consumer morale”. Consumption did pick up last year as the economy reopened, but spending “has since begun to flag”. 

Officials haven’t stood still. They have been rolling out a RMB150 billion (£16.13 billion) incentive scheme to encourage households to buy new electric cars, refrigerators and televisions. But the scheme equates to a mere 0.3% of the country’s annual retail sales. Another approach to reviving consumers’ confidence is through stock markets, says Wolf Richter on Wolf Street. 

Earlier this year, “state-controlled funds” – known as the “national team” – bought an estimated $66 billion in local exchange-traded funds. That wave of buying helped draw in foreign fund managers and sparked a 17% rally in the local CSI 300 index between February and May, but since then the sell-off has resumed as investors have taken tactical profits. The CSI 300 has fallen 36% since the start of 2021 and is still 40% short of its 2007 peak. Who said “buy and hold” always works?

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

China passed a milestone in the green revolution last month when sales of electric vehicles (EVs) and hybrids surpassed those of internal combustion engine cars for the first time. Retail sales of “new-energy” cars – the umbrella term used in China for EVs and hybrids – made up 51.1% of all sales in July, a giant leap from just 7% three years ago. The landmark follows a continuing surge in the popularity of EVs in China over the past year, even as growth in other key markets, including the US and Europe, has slowed. The number of “new-energy” cars sold last month in China, 878,000, was 37% higher year on year; sales of conventional cars fell 26% to 840,000.

The global electric car market 

To put the 50% landmark in perspective, the share of electric and hybrid vehicle sales in the US amounted to 18% in the first quarter of this year. China is by far the world’s biggest market for EVs, accounting for three-fifths of all units sold this year. According to forecasts from the International Energy Agency, some 10.1 million EVs (including hybrids) will be sold in China this year. That compares to 3.4 million in Europe and 1.7 million in the US. All other markets combined account for fewer than 1.5 million. The agency forecasts that global EV sales will grow to 20 million in 2025 and then double to 40 million by 2030 – accounting for 30% of all car sales by that point. China has been a leading market for EVs for several years, but recently the growth has been explosive. This year’s total of 10.1 million units is an eight-fold increase in just three years from 2021 when 1.3 million vehicles were sold. What’s driving the boom is that years of government subsidies and tax breaks for both producers and consumers and major strategic investment in the development of technology and infrastructure, mean that EVs are now the lower-cost option for consumers.

Why is the electric car market booming in China?

Marketing of EVs in China rarely, if ever, emphasises the environmental benefits, says Helen Davidson in The Guardian. Instead, it’s all about cost, and the range of available products, from compact city runarounds to luxury sports cars and large hybrid SUVs, powered by CATL batteries and Huawei technology. “EVs happen to be one rare area where China seems to be leading the world – high quality and low price, not to mention dizzying variety,” says Tinglong Dai, a business professor at Johns Hopkins University. “This is one of the incredible opportunities for China to dominate a highly respected marketplace. And it’s also in line with broad environmental goals in the West.” Yes, the Chinese government is motivated in part by climate and economic factors, but far more importantly the long-term investment that is now paying off was “more of a geopolitical move – a way to get to the top of the food chain of a high-end, high-status industry”.

What about exports?

They are growing fast, especially in developing markets, and Chinese companies are also investing heavily in local manufacturing and supply-chain capabilities (including batteries and raw materials) in countries such as Indonesia and Brazil. However, China faces serious headwinds in the existing biggest non-Chinese markets, the US and Europe, both of which have ramped up protectionist tariffs on Chinese cars, on the grounds that unfair state subsidies are distorting competition and making them unfairly cheap. The US, where China has achieved little market penetration, recently raised its import duty on Chinese EVs from 25% to an intentionally crippling 100%. It was part of a package of measures including increasing levies from 7.5% to 25% on lithium batteries, from zero to 25% on critical minerals, from 25% to 50% on solar cells and from 25% to 50% on semiconductors. In Europe, Chinese EVs are a far more common sight. According to EU data, the market share of EVs imported from China (including those made under joint ventures with European firms) surged from 4% in 2020 to 25% by September 2023, making China’s EV exports to Europe last year worth about €10 billion. Brussels, too, has announced punitive new tariffs.

What is the EU tariff on Chinese EVs?

Up to 48%. Brussels already imposes a 10% tariff on Chinese EVs. It will now impose additional duties of 17%-38%, depending on the extent to which individual manufacturers complied with an EU anti-subsidy investigation. The biggest exporters, including BYD, the world’s largest EV maker, will pay additional tariffs of 17%-20%. European brands such as Mercedes and Renault, which export EVs made in China, will pay 21%. Companies deemed not to have co-operated, including Shanghai-based SAIC, will pay 38%. The state-owned firm dominates the lower end of the European EV market through the MG brand. The charges came into effect last month, but are currently provisional while the investigation into Chinese state support for the country’s EV makers continues. The tariffs are strongly backed by France but opposed by Germany, which fears a costly trade war with China. Beijing has lodged complaints with the World Trade Organisation.

Is the EU’s action justified?

No, says the Financial Times. EU governments – like others across the developed world – have a dilemma. They have pledged to decarbonise their economies within decades, but they are “also moving to limit imports of Chinese green tech, without which decarbonisation will take more time and money – if it can be achieved at all”. At some point they will need to choose between their climate goals and their protectionism, and “it would be better for everyone if it is protectionism that has to give”. Europe’s problem is “not too many Chinese imports but rather too few”. It is “heartening to see the UK refraining from joining the tariff wars”.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

Hong Kong has delivered spectacular returns for investors over the long term. In the 50 years or so since the rapid industrialisation began feeding through to rising wealth, the stock market has far outstripped both Singapore – which has been a huge success in its own right – and global markets as a whole. 

Its unique status as a trade and investment gateway to China, while operating under very different economic and social conditions to the mainland, gave it a second wind from the 2000s even after its own high growth phase began to tail off. The market has been hugely volatile, but up until 2019, history showed that it was worth staying the course. 

Yet ever since widespread anti-government protests that year and the subsequent imposition of laws that curbed civil liberties and eroded Hong Kong’s autonomy, that has looked far less certain. Over the last three years, the index is down by more than 30% (including dividends).

What is the outlook for Hong Kong investment? 

To say there is a great deal of pessimism around Hong Kong is an understatement. The market has recovered from slumps before – look at the Asian crisis in 1997 in the chart – but this feels like something new. Optimists such as Mark Mobius are firmly in the minority. The consensus is more that “Hong Kong is over”, as economist Stephen Roach – once a long-term bull on China – put it earlier this year. 

The recent resignation of two British judges who served on Hong Kong’s Court of Final Appeal reflects fears that trust in the legal system has been badly damaged by the prosecution of opposition politicians and activists under new national security laws. “Hong Kong, once a vibrant and politically diverse community is slowly becoming a totalitarian state,” wrote one of them, Jonathan Sumption, in the Financial Times this week. 

“The rule of law is profoundly compromised in any area about which the government feels strongly.” (In a holdover from Hong Kong’s past as a British colony, several foreign judges sit on the top court, which was seen as helping to ensure the legal system stayed in line with other English common-law jurisdictions.) With many investors turning their backs on Hong Kong, the market seemingly looks cheap. 

The MSCI Hong Kong trades on 12 times forecast earnings; the Hang Seng benchmark – which also includes large mainland stocks as well as local ones – is even lower. Skim through mid-caps and small caps and some look startlingly undervalued. The index has rallied since the January lows – it’s up about 20% since the bottom – but that seems to be driven by inflows from mainland Chinese investors, who tend to favour specific companies. 

Unless greater optimism about China causes foreign investors to return, it seems likely that Hong Kong’s market – like the territory itself – will become more closely integrated into the mainland, which might suggest intermittent (volatile) demand for major stocks with strong mainland links and much less support for others, regardless of how cheap they get. Right now, it is difficult to see what catalyst could change that.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

The thing that doomed the American empire more than any other was its currency. When the US substituted a fake, paper-only, dollar in 1971, it set in motion a financial doomsday machine. 

For a long time, it seemed to Americans and foreigners alike to be a blessing, an “exorbitant privilege”. We didn’t have to make things; we could just print money. Since the dollar was the world’s “reserve currency”, other nations took it willingly and even lent it back to us by buying more of our bonds. But now, the great weakness of paper money is (once again) becoming apparent. Since it can be produced at will, it can also be lent out at will – but in a crunch, it gives way. 

When the US switched from asset-backed money (dollars backed by gold) to a credit-backed system (dollars backed by an IOU from the US government) it lost its anchor. Gold is limited – and precious. People are careful with it. And when the wind picks up, it holds fast. 

Typically, in a correction or a crisis, prices fall and money becomes more valuable. People discover they’ve made mistakes. Those who’ve put their faith in promises and speculations lose money. Asset prices fall. And those who have real money can buy up the distressed assets and get back to work. In a fake money system, however, the money reserves at the heart of the system – “invested” in US bonds – don’t become more valuable; they disappear. 

US banks have some $685billion in unrecognised losses. These reserves were not really a solid asset, but a dubious credit, in which the world’s largest debtor promised to pay its debts with its own fake money. Now, in a pinch, they discover that they aren’t worth what they paid for them. What can banks do? For now, it’s “don’t ask, don’t tell”. They’re hoping the Fed will lower rates this year; then, things will go back to “normal” — the value of their bonds will go back up. In other words, the only way a fake money system can hold together is for the Fed to create more of its fake money, and lend it out at fake rates. 

Inflate – and make the next crisis worse. 

China's doom loop

That is not just a problem for the US. It’s also a big problem for its fellow delusional, China. Americans thought they could buy things they couldn’t afford, using their new fake money. China thought it could sell products to people by lending them the money to buy them.

Now, the whole fandango has reached a new phase. Chinese factories turned out finished products at low prices; consumer prices, worldwide, fell. This left Chinese exporters with a lot of money – and an almost insatiable optimism. They spent, they borrowed, they invested in more productive capacity, counting on the boom to continue. Economies adjust to whatever conditions they’ve recently experienced. And after 40 years of the fastest expansion ever recorded on planet Earth, many of China’s capital investments now depend on impossibly high rates of growth.

Alas, the boom has come to an end, leaving the Chinese with unsold apartments, silent factories, empty trains – and billions of dollars worth of debt. China’s pool of cheap, abundant labour has been completely drained and wages have soared.

Once the most productive uses of credit are satiated, the new money “flows into unproductive speculation and financial skimming operations”, as analyst Charles Hugh Smith points out. “At that point, all the new money flooding into the system drives inflation.”

And now, China – with billions, perhaps trillions, of dollars worth of “unproductive speculations” – faces a credit meltdown. Its “money” is disappearing along with its customers and its asset prices.

What can it do, but replace the fake money with more fake money – just as the US does? This is probably not the end of China’s drive for full-spectrum dominance of the world economy, but it sure looks like the end of the 1979-2021 boom.

China’s economy is heading for a “generational slowdown”, says Neil Shearing of Capital Economics. Recent economic data has been “dismal”, with a slowing property market and Covid-19 lockdowns sapping growth.

Economic chaos in the West has hit the financial headlines this year, but it’s China’s structural growth challenge that could prove the more significant long-term story. On 28 September the yuan hit 7.24 to the dollar, its lowest level since 2008.

Relatively tight monetary policy and large trade surpluses had spared the yuan from the worst effects of the dollar’s dominance this year, says Nathaniel Taplin in The Wall Street Journal. An export boom helped China ride out the worst of the 2020 pandemic slump; trade has also “been one of China’s few bright spots over the past year”, with net exports accounting for a chunky 36% of growth in the first half of 2022. Yet there are signs that exports are now weakening as gloomy consumers in Europe and North America tighten their belts.

China’s economy has been paralysed by Covid-19

The World Bank has downgraded its 2022 China growth outlook from 5% to 2.8%, says Tanner Brown in Barron’s. That means that China’s growth looks set to “be weaker than the rest of the Asian-Pacific region for the first time in three decades”.

Sales in the housing market dropped by 30% year on year in the first eight months of 2022. The property slump has been exacerbated by the threat of more Covid-19 lockdowns. “Last quarter, firms told us they would not invest, borrow, or hire until their Covid-zero nightmare was over,” says research firm China Beige Book. “The nightmare continues.”

The CSI 300 stock index has fallen by 22% this year. Some investors had been betting that health measures would be eased after this month’s “all-important Communist Party congress”, where president Xi Jinping is set to secure a third term, but recent pronouncements from officials mean those hopes have “fizzled away”, says Brown.

Goldman Sachs estimates that cities accounting for roughly 25% of GDP are currently under some form of Covid restrictions, says Stella Yifan Xie in The Wall Street Journal. The bank doesn’t think China will begin easing the curbs until the middle of next year. While China has enacted modest stimulus measures, they are nothing on the scale of Beijing’s “torrential” post-2008 pump-priming, says The Economist.

Leaders don’t want a repeat of the “excess capacity... skewed pattern of production and heavy debts” they were bequeathed by that stimulus; they seem “resigned to a slowing economy”. Crackdowns on top technology innovators haven’t helped, says William Pesek in Nikkei Asia. Long-fearful of being outpaced by China, “economies from the US to South Korea need not look over their shoulders so much”.

“China’s deepening property bust is sending shock waves through the nation’s 400 million-strong middle class,” says Bloomberg News. House prices have fallen for ten months in a row. That is putting pressure on households, whose leverage has risen from 27.8% of GDP in 2011 to 61.6% at the end of 2021.

A rise in homebuyers going on “mortgage strike” – stopping payments on uncompleted flats – is piling further pressure onto developers, says Evelyn Cheng on CNBC. S&P Global Ratings thinks that Chinese “property sales will probably drop by about 30% this year”. That would be worse than the 20% slump that the market suffered in 2008. China’s housing sales amounted to more than $2trn last year, making the sector a crucial driver of the world’s second-largest economy, says Jacky Wong in The Wall Street Journal.

The mortgage boycott risks fuelling a “vicious cycle: potential homebuyers stay away, which worsens developers’ ability to raise money to complete projects”. The economic fallout from China’s zero-Covid-19 lockdowns is not helping. While Beijing has so far avoided a sector-wide bailout, the economic damage and the stress on indebted local governments are likely to force it to “provide a backstop so that homebuyers regain confidence”.

Don’t count on a “decisive policy shift”, says Nicholas Spiro in the South China Morning Post. Problems in Chinese property are “a direct result of Beijing’s efforts to deleverage the economy and de-risk the financial sector”. To rescue the property developers would be to abandon that goal. Beijing won’t unleash a “shock-and-awe... response” because, as Tyran Kam of Fitch Ratings puts it, the aim is to “stabilise the property sector without bailing it out”.

John Lee, the ultra hard-line Beijing loyalist who oversaw the introduction of Hong Kong’s bitterly controversial anti-sedition law, was anointed this week as the territory’s next chief executive. The selection, and Lee’s appointment, is another step in the steady dismantling of the “one country, two systems” principle that is supposed to give Hong Kong a special status until 2047.

Meanwhile, 800 miles to the north-east, Shanghai – the city that hopes to poach Hong Kong’s crown as China’s great financial hub – further tightened its already draconian lockdown measures. It came after president Xi Jinping vowed to “unswervingly” double down on the government’s increasingly controversial “zero-Covid” policy. Millions remain confined to their homes with no end in sight. And in both Hong Kong and Shanghai, question marks are growing over the cities’ futures as global financial hubs.

What’s happening in Hong Kong?

People are leaving. After two years of on-off pandemic restrictions and uncertainty, Hong Kong was battered earlier this year by a far deadlier fifth wave of the virus. For a period in March, the territory was registering tens of thousands of cases a day and had the world’s highest Covid death rate per capita. It meant that just as much of the world was pivoting to living with the virus, Hong Kong – which implemented a “dynamic zero-Covid” strategy aligned with mainland China – retained some of the strictest restrictions anywhere.

That has damaged Hong Kong’s lustre as a global hub, and sped up an exodus of foreign business and talent. “It’s an unarguable fact that we have a brain drain and some senior management of some corporates have left Hong Kong,” said chief executive Carrie Lam (who will hand over to Lee on 1 July).

How bad is it?

Hong Kong saw a net outflow of almost 157,000 residents in the first three months of the year. That’s a big chunk of people in a city of 7.4 million, with reports of well-heeled residents getting out so fast they are abandoning their expensive cars in car parks. But that might not be the end of it.

According to Hong Kong’s Public Opinion Research Institute, almost a quarter of the city’s residents have plans to leave. Another survey found almost half of European companies with offices in the city were considering leaving. The Hong Kong Chamber of Commerce has warned the city is facing an exodus of educated workers not seen since the run-up to the return to Chinese sovereignty in 1997. Meanwhile, the expected windfall for Hong Kong, as mainland China makes it more difficult for its companies to list in the US, has not materialised.

But won’t Hong Kong bounce back?

It’s certainly too early to write it off, says Robin Harding in the Financial Times. “Economic geography is remarkably durable” and the legacy of 200 years as a trading centre will not be lost easily. Hong Kong’s most significant ongoing advantage is China’s policy of strict capital and currency controls.

While they remain in place, Hong Kong – with its separate convertible currency pegged to the US dollar – will remain the key conduit for Chinese investors wanting to diversify into foreign assets, and for foreigners wanting to access China’s markets. All that could change fast if China made the renminbi fully convertible and lifted capital controls – “but that way is still a long way off”.

So the city is safe?

Lee has pledged to boost the economy and protect its status as a financial hub. And as long as Chinese money flows through the territory, it will remain important, says Harding – benefiting from low tax, critical mass and decades of legal expertise. Yet its lustre is diminishing by the day. “Without freedom, it is hard to innovate”: we can expect the talent drain to continue.

Moreover, “in any undemocratic jurisdiction, there is the risk of a descent into outright gangsterism, if those in power are corrupt or erode the rule of law”. Business depends on certainty of contract and ownership: “its loss would be the death knell for any financial centre”.

What about Shanghai?

There, the Covid lockdowns have been even harsher than in Hong Kong. Thousands of foreign bankers, traders and investors have been confined to their homes, with some even struggling to secure food and other essentials. “What happened in Shanghai is shocking to most of the people. Few would have imagined things will get out of hand to such an extent,” Melvyn Xu, a Shanghai-based private-equity investor, told Reuters.

In the short term, Jörg Wuttke, president of the European Union Chamber of Commerce in China, estimates the country has lost about 50% of all European expatriates since the pandemic started – and predicts a further exodus this summer when the school year ends. “Shanghai as a marketplace has been grossly overplayed,” says Fraser Howie, an independent China analyst. “Shanghai has always been a state-owned enterprise creation.”

What’s the bigger picture?

Economists are busy downgrading Chinese economic growth forecasts, China's stockmarkets have fallen sharply in recent months and doubts are growing over the government’s ability to turn things round. Stephen Roach, the veteran economist and ex-Asia chairman of Morgan Stanley, is a long-time China cheerleader.

But in a recent article in Project Syndicate he wrote that “the China cushion” – the economic heft that helped drive the world through the global financial crisis in 2008 – had “deflated”. Shan Weijian, the chief executive of PAG, a Hong Kong-based private-equity firm, recently told investors the Chinese economy “at this moment is in the worst shape in the past 30 years”, according to the FT.

China has officially set a target date of 2035 for Shanghai to be an international financial centre with “major global influence”. Right now, as dark clouds hover over the Chinese economy, that looks a long way off.

Chinese leader Xi Jinping faces a moment of truth. The highly infectious Omicron variant of the virus that causes Covid-19 took hold in Shanghai, which prompted the government to lock up its residents for more than a month. That has left people struggling to find food and the elderly unable to get medical treatment. The fear is that Beijing will be next, which has led to the emptying of supermarket shelves and school closures. Xi is sticking to his guns on the zero-Covid strategy, deeming it to have been a success earlier in the pandemic, and relying on strict mass testing and quarantine to control the spread of the virus.

Lockdown fatigue takes hold

But given that the new variant is more infectious and has already spread more deeply into the population than in earlier outbreaks, lockdowns are starting to look even more obviously pointless than usual. That is generating a backlash among an “exhausted” population, says Chris Buckley in The New York Times. Residents under China’s past lockdowns complained about the “draconian restrictions”, but this time there are “more critics and bolder ones, including economists and business executives”. They are warning that, despite government attempts to stimulate the economy with infrastructure investments, the “chronic uncertainty” over “when it is possible to travel, spend, buy property or invest in business” is crippling consumer and company confidence and threatening a major economic crisis.

Some public officials are also starting to worry about the economic impact, and are privately complaining about Xi’s “ignorant” approach, says the Financial Times. This presents Xi with a dilemma, as his commitment to the zero-Covid strategy is based as much on political considerations as anything else. He has been a champion of the strategy and would appear weak if he backed away now, and would have to take the rap as Covid infections and deaths spiralled. He won’t want to risk that as the Party conference looms, where he aims to take an unprecedented third term as head of the party and state. At the same time, his “carefully cultivated image” as a “strong and competent leader” could also be “badly tarnished” if the government “blunders into an economic crisis” as a result of the Covid strategy.

Maoist mobilisations are hard to stop

That’s the trouble with “Maoist mass mobilisations”, says Eyck Freymann in The Wall Street Journal – China’s political system is good at starting them, bad at stopping them once they have begun. Mao’s Great Leap Forward proved this. Xi’s “bold embrace” of zero-Covid is beginning to look like a similar mistake. Xi will be aware of the historical parallels, so it’s possible he is aware that the result will be a turn away from the “open-facing, gradually marketising country” that China was before the pandemic. He may now explicitly seek to derive legitimacy less from GDP growth and more from his “common prosperity” strategy of preserving social order and redistributing wealth. If so, China is set to become a less dynamic and more static and ideological society – one in which “the party rules and the masses follow”.

Just over a month ago the resurgence of Covid in China sent shockwaves around the world and fears mounted that lockdowns could derail the global economic recovery.

Events in China this weekend did little to dampen those fears, with Beijing warning that Covid was spreading undetected and cases would spiral further, which caused a steep sell-off in global markets on Monday.

So what is going on and how may it affect you?

What is happening in China?

China reported 3,266 symptomatic Covid cases and close to 20,500 asymptomatic cases on Monday.

The higher numbers of cases have prompted authorities in Beijing to impose mandatory testing for anybody working or living in the diplomatic district of Chaoyang, which accounted for 26 of Beijing’s 47 symptomatic cases since Friday, says the Guardian.

And that is not all. While only specific apartment buildings have been forced to shut down in Beijing and schools are still open, the Chaoyang business district has introduced curbs on in-person group activities, says CNBC.

One part of the district has seen a halt in main business activity with entertainment venues, indoor gyms and restaurants forced to close from Monday morning. Stay-at-home guidance has also been issued for those living in the area.

Why are cases rising and why does any of this matter?

The rising number of cases raises the spectre of a lockdown in the capital, in the same way Shanghai has done over recent weeks. Shanghai, China’s largest and wealthiest city, has accounted for the majority of China’s cases with 19,455, and has been beset by lockdowns over the last four weeks.

A strict lockdown was imposed on the city’s 26 million residents on 5 April.

It comes after Shenzhen, sometimes referred to as China’s Silicon Valley, also introduced a lockdown in March.

The rising case numbers put further pressure on Xi Jingping’s “zero-Covid” policy inoperation since the virus was first detected in Wuhan in 2019. Its approach involved imposing hard citywide lockdowns, mass testing and travel restrictions soon after any outbreak of cases.

While this approach worked well in the earlier stages of the pandemic, the more virulent Omicron variant has put the future of this policy into doubt.

China’s population has little natural immunity – vaccination booster rates are low with just 50% of the population having received a third jab. Worse yet, this figure is far lower for those aged over 80, at just 20%.

“We calculate it would take more than three months and seven months respectively, to bring vaccination levels to above 70% for the two groups,” says Frederique Carrier, head of investment strategy in the British Isles and Asia at RBC Wealth Management.

How badly have markets been affected?

As Hargreaves Lansdown’s Susannah Streeter points out, markets sold-off “as worries ricochet to Asia and Europe about the more aggressive monetary policy path set to be taken by the US Federal Reserve”.

Global markets have fallen hard this week with many major bourses deep in the red. The Shanghai Composite index has shed more than 5%; Japan’s Nikkei 225 is down by 1.5% and the FTSE 100 is 1.9% lower.

Brent crude oil fell more than 5%. China is the world’s second largest consumer of Brent crude.

How will this affect consumers in China?

The Covid measures are causing consumers to flock to supermarkets in a desperate bid to stock up ahead of potential food shortages.

As a result, supermarket chains such as Walmart and Carrefour have more than doubled inventories and extended their opening hours at weekends. Meanwhile, Meituan, a Chinese online shopping platform, has taken other measures to cater for panic buying including increasing its delivery staff.

The Global Times, a state-owned newspaper, has tried to reassure its citizens that Beijing has sufficient supplies and the situation would not become as severe as Shanghai, but the assurances have done little to prevent panic buying.

What does it mean for the global economy?

The country’s outbreak of cases comes at a time where Russia’s war with Ukraine was already raising prices, with inflation heading towards double digits in several economies, including the US and the UK.

Hargreaves Lansdown’s Susannah Streeter says that there is concern that prolonged lockdowns will hit employment and lead to a sharp slowdown in growth as well as sparking fresh shipping logjams and supply chain issues.

China is the world’s manufacturing powerhouse, accounting for almost 30% of the world’s global manufacturing output in 2019, according to the United Nations Statistics Division.

The economic impact in the short-term may be sizeable with higher prices for goods. But there are many reasons to stay optimistic, says Andy Rothman, investment strategist at Matthews Asia.

This is because it is likely that cases will peak in Shanghai, which has accounted for 90% of the rise in cases soon, and cases still remain low relative to China’s population. Another positive sign is that most of the cases in China are asymptomatic, Rothman says.

However, one potential silver lining for UK consumers from China’s slowdown is cheaper petrol at the pumps, says The Telegraph. If China’s lockdowns result in lower economic activity and a slump in the demand for oil, petrol prices could follow suit.

Will China ease stimulus?

China’s government is expected to initiate a major stimulus programme to reinvigorate the economy by the time of the autumn Party Congress, when Xi Jinping will be awarded a third, five-year term as party chief.

The People’s Bank of China already cut its reserve requirement ratio (RRR – the amount commercial banks should hold rather than invest or lend out) by 25 basis points for all banks and 50 basis points for certain small banks.

Carrier says​ RRR cuts may not be enough to revive the economy as “these are smaller than the typical cuts of 50 or 100 basis points, perhaps due to weak credit demand and concerns regarding the inflation outlook”.

She expects further tax cuts, city-level housing policy relations and more sponsored infrastructure development as measures that China may take to ease stimulus.

Rothman says that while lockdowns are likely to lead to short-term higher food prices, he doesn’t expect consumer price inflation to rise enough to interfere with the Chinese central bank’s plans to further cut interest rates and boost credit at a time when the Federal Reserve in the US is raising interest rates.

“The consumer price index (CPI) is rising in China, but not nearly enough to make the central bank nervous about easing. In the first quarter, China’s CPI rose at a healthy 1.1% pace, compared to 8% in the U.S,” he says.

Though RBC has downgraded China’s GDP growth forecast from 2022 to less than 5% compared to a previous forecast of 5.5%.

Ultimately how long Shanghai remains in lockdown may be key to assessing the economic fallout from China’s rising cases.

Almost two years after Covid restrictions were introduced, England is on course to lift them later this week. But restrictions in China are being reintroduced to combat the country’s worst outbreak in two years.

China has imposed a one-week lockdown in the city of Shenzhen, due to rising Covid cases. The city, sometimes described as China’s Silicon Valley, is home to the world’s fourth-largest port, Yantian International Container Terminals.

“Yantian is thought to handle about 90% of China’s vast electronics exports, making it a key cog in global trade,” says The Times. So what is going on and what do China’s new restrictions mean for supply chains and the economy?

Why are cases rising and how severe are new measures?

Authorities have thrust around 17 million of Shenzhen’s residents into lockdown, as the number of Covid cases soars. They have also imposed a travel ban in the Jilin province, home to more than 24 million residents. Jillin residents have been barred from leaving their homes, and nobody can leave the province without police permission.

The stricter measures come after cases in China almost doubled on Monday to nearly 3,400, prompting measures that could threaten half of China’s GDP, says Bloomberg.

China’s surge in cases is thought to be related to a sharp rise in neighbouring Hong Kong; Shenzhen tightened its management of cross-border shipping after Hong Kong reported almost 27,000 cases and 250 deaths on Monday. China is still pursuing a “zero-covid policy”, hence the drastic lockdown.

What is China’s “zero Covid” policy?

China has maintained a “zero-Covid” policy since the virus was first detected in Wuhan in 2019. Its approach involved imposing hard citywide lockdowns, mass testing and travel restrictions early on after any outbreak of cases. This is the equivalent of UK prime minister Boris Johnson issuing a stay-at-home order and shutting pubs every time cases spike.

But the emergence of the omicron variant has put China’s zero-Covid efforts into doubt. Barry Norris, manager of the Argonaut Return Fund, has previously told MoneyWeek how the world economy is at threat due to this strategy because of the resulting continuous lockdowns and their effects on supply chains.

Which large companies have been affected?

Chinese lockdowns are wreaking havoc on a number of international companies who have halted operations in the country. Apple supplier Foxconn said it had suspended operations in the city until further notice. It told the BBC that it would reallocate work among backup plants in an effort to minimise any disruption.

Car manufacturers are also feeling the pinch. Toyota has shut its factory in Changchun and has not said when it might resume operations. Volkswagen followed suit, shutting its operations in Changchun, although the company hopes to resume later this week.

What does this mean for the global economy?

The main economic concern is that it will further damage supply chains at a time when they were still fragile from the effects of previous lockdowns in the last two years.

Russia’s invasion of Ukraine last month is also exacerbating supply chain issues. Both countries are agricultural powerhouses, so Western sanctions and the destruction of Ukraine’s agricultural infrastructure threaten to send the price of key commodities soaring. Prolonged lockdowns in China may make this worse.

With many people in the UK bracing themselves for inflation of around 7% this year; and US inflation already at a 40-year high of almost 8%, central banks might feel under pressure to raise interest rates more swiftly and sharply than previously expected, even although the rising costs are arguably disinflationary in the longer run (because they squeeze consumer spending).

China set itself a GDP growth target of 5.5% this year. This was already considered somewhat ambitious and it’s now very much in doubt, says Bloomberg: “With tighter virus controls in places like Guangdong and Shanghai disrupting manufacturing, an ongoing contraction in the country’s huge property market showing no signs of easing and an oil price hike pushing up business and consumer costs”.

How have markets reacted?

China’s outbreak has rattled markets – the Shanghai Composite stockmarket index fell 5%, while Hong Kong’s Hang Seng index, which hosts many Chinese tech giants, lost more than 6% on Tuesday. And with China the world’s top importer of crude oil in 2020, benchmark crude oil prices fell below $100 a barrel on Tuesday.

But some analysts think any disruptions will be short-lived and China and the wider world will be able to weather the storm. Yeang Cheng Ling, senior investment strategist at DBS Bank, said: "Such lockdowns have happened before, and (cities) have re-opened within a short period of time once the number of Covid cases were within control”.

While the recent restrictions imposed by China are the most severe since 2020, they still are still less stringent than those imposed at the start of the pandemic. And while Zhang Wenhong, a Chinese infectious disease expert, has dubbed the recent outbreaks as the "the most difficult period in the last two years of battling Covid" he says the outbreaks are still at an early stage.

So, for now, disruption may be short-lived. But UBS analyst Grace Chen said if the lockdowns spread to other cities such as Shanghai, this would spell more trouble for production and supply chains.

Can anything stop rising inflation? asks Daniel Moss on Bloomberg. How about a Chinese slowdown? The world’s second-biggest economy grew at a record 18.3% year-on-year in the first quarter of the year but has slowed sharply. GDP rose by an annual 4.9% in the third quarter, the slowest pace in a year and down from the 7.9% rate recorded between April and June, says Katie Silver for the BBC. Soaring commodity prices have seen many provinces impose electricity rationing, which is weighing on industries such as cement, steel and aluminium smelting.

China’s benchmark CSI 300 stock index is down by 6.5% since the start of the year. A crackdown on debt in the property sector – highlighted by the woes of developer Evergrande – has also hit construction activity, says Martin Strydom in The Times. “New construction starts slumped in September for a sixth straight month, the longest series of monthly declines since 2015.”

China’s slowdown has been “more pronounced than anticipated”, says Moss. Lower Chinese demand could cool the rally in many commodity prices. It won’t necessarily be deflationary, however: closed factories will reduce the global supply of essential goods. Factory-gate prices, a measure of the prices manufacturers charge wholesalers, grew at their “fastest pace since records began in 1996” last month, says Strydom.

China has been contending with a “triple shock” from power cuts, the pandemic and the property slowdown, says The Economist. A Covid-19 “cluster that began in Nanjing in July, prompted strict, localised lockdowns [and] airlines were operating at less than half their full capacity in August”. Year-on-year growth could slow further “to 4% or below” in the final quarter of this year.

Shares in troubled Chinese property giant Evergrande and its property management unit were suspended from trading in Hong Kong on Monday, amid reports that a major transaction is underway.

The suspension came just before it looked as though Evergrande was set to miss yet another payment.

According to the Global Times, China’s state-owned newspaper, Chinese rival Hopson Development plans to buy 51% of Evergrande Property Services. However, there’s not yet been an official confirmation of the deal, and share trading remains suspended.

So what’s going on?

The Evergrande saga

Evergrande, China’s most heavily indebted property company, has been in the headlines in recent weeks for all the wrong reasons. Its shares have fallen by 80% since the start of the year.

The company, which is struggling under a debt pile of $305bn, missed a $47.5m bond payment last week. Before that, it failed to make an $83.5m coupon payment on some of its outstanding dollar debt. Both have grace periods of 30-days. So it is too early to say whether investors will be stomaching huge losses or not (though the omens are not great).

Now, Bloomberg says, the embattled firm is due to miss a third payment: a dollar bond worth $260m that is guaranteed by Evergrande, called Jumbo Fortune Enterprises. Because the due date is 3 October, it was effectively due on Monday and failure to do so would count as default, as the debt has no grace period.

As a result of all this, the company has been scrabbling to raise cash by selling assets. This is the driver behind the sale of the property unit. Evergrande said in a regulatory statement to the Hong Kong Stock Exchange, that it was suspending its shares “pending the release by the company of an announcement containing inside information about a major transaction.” Although, as of Tuesday, share trading remains suspended with no fresh news on the deal.

Why is Evergrande facing so much trouble and could its demise reverberate beyond China?

Much of the Evergrande’s importance on the global stage has to do with the fragmented nature of China’s property market. Reuters reports: “With liabilities equal to 2% of China’s GDP, Evergrande has sparked concerns its woes could spread through the financial system and reverberate around the world, though worries have eased somewhat after the central bank vowed to protect homebuyers’ interests.”

Calling China’s real estate market huge would be an understatement: it was worth $52trn in 2019, according to Goldman Sachs, and the sector accounts for 29% of Chinese GDP. Yet around 20% of supply – roughly 65 million homes – are underoccupied, reports Business Insider.

There is too much housing and too little overall demand for homes to live in. This gap has been filled by speculators and small investors, but both are now under pressure from regulators who want to dampen house price growth.

“Speculators and investors are being blocked by government policies in cities where they want to buy, and some are increasingly concerned that developers will be unable to complete the units they are promising to build,” reports Foreign Policy.

Real estate is seen as a more reliable investment vehicle than the stockmarket in China – about 70%-80% of household wealth lies in real estate, reports CNBC, underscoring how significant a default by the country’s second-largest property developer would be. So it is unsurprising that China has been asking state-backed firms to snap up Evergrande’s assets, having ruled out the chance of bailing it out.

Should markets worry less now about a default?

Can markets take a breather now that more than half of Evergrande’s property unit could be purchased, bringing in much needed capital for the firm? Perhaps not. Lisa Zhou, Bloomberg’s Intelligence analyst, says that the potential deal “could bring short-term relief” to the liquidity problem and effectively buy the company time to fix its onshore liabilities.

However, the spillover effect into other property developers – many of whom face similar if slightly less acute problems to Evergrande – are already showing up in markets. Chinese developer Sinic Holdings was downgraded by Fitch with concerns over a bond repayment coming up in mid-October. Homebuilder Fantasia saw its bonds collapse in half, after it failed to make a $206m payment.

As my colleague John pointed out last week, it seems unlikely that Evergrande will trigger another “Lehman Brothers” moment – at least, for global financial markets.

But at the same time, stabilising China’s real estate market will take a lot more than just the sale of Evergrande’s property unit – and it has implications for the country’s growth for years to come.

Quick reminder: don’t forget to get your ticket for the virtual MoneyWeek Wealth Summit. Early bird prices are still available, but not for long – it promises to be an extremely timely event this year, given all the upheaval we’re seeing. We’ll be asking some of the smartest financial experts around to help guide us through it all. Book here now.

And conveniently enough, upheaval is what we’re talking about today.

Like most of the rest of the world, China has been trying to cut down on fossil fuel usage. China is heavily dependent on coal; it accounts for about 70% of its electricity generation.

But coal is dirty in a very visible manner – pollution and smog always causes discontent. And with China hosting the Winter Olympics early next year, the country has an added incentive to clean up its act.

So it tells you that something has gone very awry when you hear that China is now telling coal miners to dig for all they’re worth, smog be damned.

China’s U-turn on coal sums up what’s gone wrong with the recovery

China’s state-owned miners have been commanded, reports Bloomberg, “to produce coal at full capacity for the rest of the year even if they exceed annual quota limits.”

Meanwhile the price of the muckiest type of coal – lignite from Indonesia – has hit a record level, more than quadrupling in price in the past year.

This is partly because China is still refusing to buy from Australia, but also because all of the energy companies have been ordered to secure whatever supplies they need for winter. “Blackouts will not be tolerated”, apparently.

That’s sent the price of liquefied natural gas (LNG) through the roof too. As one commodities analyst tells Bloomberg: “They will bid whatever it takes to win a bidding war”.

China’s actions show that, as of now, keeping the lights on is more important than keeping the skies clear. Little wonder: factories are already being shut down by blackouts, which meant that September saw the first drop in manufacturing activity since February 2020.

So what’s gone wrong? What’s going on in China is really just an exaggerated (and really quite important) version of what’s happening everywhere else. Surging demand is meeting restricted supply, and it’s all being made worse by governments jumping the gun when it comes to ideals of decarbonisation and energy transition.

Why supply has lagged demand so badly

Every country has its own variations on this theme, depending on where they get their energy from. But the underlying issue is similar across the entire world.

On a broad economic front, post-lockdown demand from consumers has rebounded more rapidly than producers of goods and services were prepared for.

This makes sense. If you’re running a widget factory and suddenly no one can buy your widgets, it makes sense to err on the side of caution, even if it seems likely that demand will rebound when the shutdown ends. In fact, you probably have to err on the side of caution because you’ll need to conserve cash.

So it was always likely that supply would lag demand once the lockdowns started to ease off. Hence the supply chain disruption (which is also made worse by the fact that while domestic economies have opened up to a great extent, the global economy – which relies on smooth cross-border movement – has not opened up to anywhere near the same extent).

This has all been exacerbated by another factor. On the energy front, producers cut back due to lack of demand. But they have the added disincentive of everyone talking about stranded assets and “net zero” and “peak oil demand” and all the rest of it.

It’s not very tempting to invest in extra capacity to meet demand if all opinion and policy points to your products being phased out in the long run. That makes for a tricky balancing act.

So we’re dealing with some big mismatches. In some ways, the world is acting as if we transitioned to net zero in 2020 when in fact, we just switched all the lights off for a short while.

Now that we’re switching them back on, we’ve realised that a “return to normal” also means a return to normal levels of energy consumption, and right now we don’t have a substitute for the dirty fuels that we’re so desperate to stop using.

Inflation is looking less and less transitory

What does all of this mean for investors?

A slowdown in the world’s second-largest economy is not good news. If Chinese factories are switched off, it means they’re not making stuff, which means the energy supply crunch will also morph into a goods supply crunch.

Overall, this means rising costs for companies. And that will almost certainly be passed onto consumers. But consumers aren’t going to take that sitting down either, because there’s a labour supply crunch, too. Which means they’ll be demanding higher wages. Which starts the whole merry-go-round off again.

This is already happening. In Germany, the FT reports, “increasing numbers of German workers are demanding higher pay amid rising inflation, with some going on strike”. For example, the country’s biggest union, IG Metall, is demanding a 4.5% pay rise, plus added pension benefits, for workers at one group of companies in southern Germany.

It’s a similar story in Australia. Capital Economics notes that “union officials’ inflation expectations have surged… A push by union officials to offset rising living costs coupled with severe labour shortages provide fertile ground for wage hikes in upcoming enterprise bargaining agreements.”

To be clear, I’m all for wage rises. A pendulum swing back to labour from capital has been overdue for some time and it’s at the heart of our political discontent. But as we’ve also pointed out on many occasions, this sort of shift would represent a huge change in the investment environment from the one most of us have lived through so far.

What does that mean for your portfolio? It means that if you haven’t given any thought to protecting your wealth from an environment of potentially weaker growth and relentlessly rising prices, then you probably need to.

The “death of the 60/40 portfolio” is one of many topics we’ll be discussing at the Wealth Summit. So book your ticket now.

“Recent crackdowns have proven that few sectors are safe from Beijing’s control,” says the FT’s Lex column. “No industry looks as vulnerable as Macau’s gambling market.” Shares in the territory’s casino operators fell sharply amid a regulatory review that may end up cutting the number of casino licences in the world’s largest gambling hub. “Should the new laws limit the number of licences below six, some operators could go out of business” when all current permits expire in June 2022.

Even if that doesn’t happen, “it is clear that Macau will be more demanding than in past years”, says Katrina Hamlin on Breakingviews. Operators may face “unprecedented micromanagement, including state representatives scrutinising daily operations, and stricter oversight for junkets, which organise visits and credits for high rollers”. There’s even a suggestion that firms may require government approvals to pay dividends.

The message for markets extends beyond Macau, says Shuli Ren in Bloomberg: China is serious about its “common prosperity campaign”. Hence shares in Hong Kong’s four biggest property developers also tumbled after reports that Beijing has “asked the territory’s real-estate billionaires to resolve the city’s housing crisis”. The high cost of property in Hong Kong is often blamed for fuelling the widespread political protests in 2019. Investors now fear developers could be forced to donate some of their large land banks to the government.

Deflating Hong Kong’s real-estate bubble won’t just mean squeezing the tycoons – it will also require a big shake up in tax policy, adds Jacky Wong in The Wall Street Journal. The territory earns twice as much from land sales as income tax, which is partly why tax rates have stayed so low until now. “Hong Kong’s housing market has produced immense wealth for some... Leaner times could be ahead.”

Chinese property is in a “bubble of epic proportions”, says Matthew Brooker on Bloomberg. On some measures it “overshadows the pre-global financial crisis” boom in US housing valuations. In Shenzhen a flat costs 43.5 times the average annual salary, three times the figure for London. The market “stands comparison with the Japanese real estate bubble of the 1980s”, which inflicted a “lost decade” on the economy after it burst in 1990.

Turmoil at Evergrande

This week has brought new turmoil at Chinese property developer Evergrande. The group has been struggling to service a $300bn debt pile. Once “the world’s most valuable real-estate group”, today Evergrande is “the world’s most indebted property developer”, says Ian Verrender on abc.net.au. It is trying to sell assets to raise cash, but has warned that it could default should those efforts fall short. The company’s debt sells for less than 30 cents on the dollar. “Contractors are lining up for payment” while “tens of thousands of hopeful apartment owners are fretting” that their deposits are about to “evaporate”. Evergrande’s shares have fallen by 79% since the start of the year.

The property market has been a “key driver of economic growth” in China ever since it liberalised its economy, says Edward Witte in The Diplomat. “Owning property... is seen as a benchmark one must reach before getting married and starting a family.” The result? An estimated 70% of the country’s household wealth is in bricks and mortar. On the broadest definition, the property sector accounts for “a quarter of the Chinese economy”, says Ambrose Evans-Pritchard in The Daily Telegraph. That is “three times the relative weighting of America’s extreme bubble in 2007”. Half the world’s cranes are in China. The Communist Party has concluded that soaring prices are “triply corrosive”. Expensive housing raises financial risk, worsens inequality and is stopping families from having children.

The clampdown cycle

Authorities have clamped down, says The Economist. Last year, regulators imposed caps on how much property debt banks can hold and demanded that developers adhere to rules requiring them to keep debt under control. The results are already apparent: “Sales of new homes in 30 cities… fell by 23%”, year-on-year, in August.

Some have drawn parallels between Evergrande and the 2008 meltdown at Lehman Brothers, says Evans-Pritchard. But the comparison looks implausible because “the state retains iron control over banks”. Regulators appear to instead be “orchestrating a disguised soft-landing” for Evergrande. Chinese property regulation has historically been “stop-start”, says Brooker. Authorities try to restrain speculation, but whenever the economy weakens “the money taps open… the urgency of [dampening] home prices is temporarily forgotten”. Then the cycle repeats. Some think the latest clampdown will go further. But that would risk a “debt crisis” and a prolonged recession. The property sector “is simply too big, too overvalued and too important to the economy” to be tamed.

Like almost every other country in the world, China has a persistent problem with bubbly house prices.

Unlike most other countries, China is quite keen to pop this bubble.

The danger is that defusing house price bubbles is the financial system equivalent of juggling nitroglycerine.

Which is why a lot of investors have been fretting about the fate of a property developer that some are already calling “China’s Lehman Brothers”.

The trouble with property bubbles

As with every other housing market in the world – whether or not they operate under nominally communist regimes – Chinese house prices are mostly a function of how much money is sloshing around the system to buy them.

When money is tight, prices go down; when money is loose, prices go up.

The availability of money is in turn a function of how worried the authorities are about economic growth at any given point.

After the 2008 financial crisis, China opened the floodgates and spent lots of money on infrastructure, for example, to keep growth rising. Many of these projects didn’t make any returns (in other words, they were wastes of money rather than productive investments – “mal-investments”, as the Austrian economists would put it).

But as long as they keep people busy and they keep the GDP figures rising, that’s what matters.

Anyway, there’s a problem here. As we’ve seen elsewhere in the world, when house prices rise beyond the reach of young people and the aspirational classes, populations get angry. There is no more visible symptom of wealth inequality than soaring house prices.

That’s hard enough to tackle in a liberal democracy; in a nation whose social contract is based on the idea that if they tolerate a centralised authoritarian government, everyone will get richer at roughly the same pace, it’s actively quite dangerous.

So, as Matthew Brooker notes on Bloomberg, China has always flip-flopped about ways to control speculation in the property market.

Now, however, as analysts at Nomura put it, Beijing is showing “unprecedented determination” to cool the housing market down. This is all part of Xi Jinping’s crackdown on visible wealth inequality, branded as “common prosperity”.

The stress is showing in the system. The most obvious red flashing light is around Chinese property developer Evergrande.

The company has been in trouble for a while, but things really seem to be coming to a head now.

To cut a long story short, Evergrande’s sorry tale is the same as all the other sorry tales around property going bad – including the Great British classic, Northern Rock. It over-reached itself and then got caught swimming with no trunks on when the tide went out.

Put very simply, Evergrande relies on money from advance sales of the properties it develops to actually build the properties in question. But because of a crackdown by China’s authorities, sales have dried up. So it can’t finish its properties because it can’t pay its suppliers and so it can’t raise more cash – it’s a vicious circle.

Credit ratings agencies have lined up to downgrade the developer, and the price of its bonds has collapsed, indicating that investors believe it will default. Obviously, its share price has collapsed too.

The risk is that this spreads to other property developers. Evergrande just happens to be the largest canary in the coalmine, but there’s an aviary full of them.

This is “contagion”. Property developers go bust, the banks and investors who loaned money to them lose out, and you get a big credit crunch. We’ve seen this film before, which is why some people have been describing Evergrande as “China’s Lehman Brothers”.

This is probably a chronic crisis rather than an acute one

So is this something you need to worry about? It’s a good question and I’ll warn you right now that I don’t have a strong view as to the answer.

However, it’s worth thinking about what might happen. First, it’s always worth remembering that, after 2008, the world knows what the response to a banking solvency crisis is: you print lots of money to keep the system from collapsing and you recapitalise the banks or bail out whoever you need to. Would the Federal Reserve, America’s central bank, ever let Lehman go bust today? You have your answer.

Second, the Chinese authorities have even more leeway to do this sort of thing than governments in the developed world. So, in theory at least, the system should be underwritten. It shouldn’t be a Lehman Brothers moment in terms of creating unstoppable waves of panic.

Indeed, even as I write this, I’m seeing reports on Twitter that Evergrande will be allowed to “reset” its debt terms to avoid a cash crunch. In other words, it’s getting bailed out, just as China stepped in previously to bail out a bad bank – Huarong.

So we know the authorities will abide by the post-2008 rulebook.

Will it work? That’s the other question. The problem is that defusing these things is not simple; there are a lot of moving parts. Even in a centrally-controlled financial system whose overseers have no qualms about stepping in (which to an extent is every financial system today, not just China’s), there are side-effects and consequences.

China once again faces the big problem: all of that past malinvestment means that it can’t calm down its property sector without slowing the economy. So the juggling act has to be based on which issue causes the most social upheaval: high house prices or weak growth?

Meanwhile, on a global basis, China is a more important driver of the global economy than it once was. Does it matter if it slows down as long as the rest of the world is picking up the slack? Probably not, but I’d keep a close eye on what unfolds rather than feeling very confident about that.

Finally, when you’re facing internal economic strife, there’s nothing like an external enemy to give you a focus. I’m not keen on getting melodramatic about geopolitics here, and I do think that the rush to highlight Taiwan as a global flashpoint is perhaps a bit too hasty. But again, it bears watching – will China resolve its internal conflicts by trying to get its citizens to focus on external ones?

So sorry – not very conclusive this morning. All I can say is that this doesn’t call for any obvious changes to your asset allocation and I’m pretty sure it won’t be a Lehman moment (though I wouldn’t be surprised to see some assets having a turbulent ride if someone needs to liquidate to cover losses elsewhere at some point).

But do keep an eye on China.

We’ll no doubt be covering all of this in future issues of MoneyWeek magazine. Subscribe now to get your first six issues free.

It has been a volatile few months for Chinese markets. Beijing has cracked down on a host of different industries providing one regulatory shock after another for investors.

But while many companies, such as fintech and tech companies, have been hit hard by regulatory intervention, other companies, such as semiconductor companies, have thrived.

China’s war on tech and firms

From big tech firms to e-commerce and education, China has increased scrutiny on multiple sectors.

Most recently, China released an article likening the video games industry to “the opium of drugs”. Shares in major video companies such as Tencent fell, prompting Tencent to introduce emergency measures such as introducing curbs on how long minors can play its “Honour of Kings” game. Video game hours for holiday periods were slashed from 1.5 hours to one hour, among other restrictions.

In July, Chinese regulators sparked a sell-off in both education companies and tech companies after a leaked memo proposed radical changes to the country’s $100bn private-education sector, including banning companies from accepting foreign investments, from being acquired, from raising funds via the stockmarket, and from providing tutoring services at weekends and on public holidays.

And the Cyberspace Administration of China (CAC) launched a cybersecurity review into Didi Chuxing dubbed “China’s Uber” – at the start of July to investigate allegations of poor working conditions just days after the firm listed through a $4.4bn IPO in New York.

So why semiconductors?

The Chinese semiconductor industry, meanwhile, has been helped by a multibillion dollar government plan by China, mainly to prevent competition from American firms, reports the Financial Times.

This is backed by a 446% rise in venture capital investment in Chinese semiconductor companies in the second quarter of the year to $8.9bn, says Prequin, an alternative-finance analytics firm.

China is aiming to have 70% of its semiconductors manufactured at home by 2025, a 30% rise from current levels.

“For China, the most important areas of technology include semiconductors, aviation and life sciences. When President Xi talks about the importance of technology, he has expressly elevated the manufacturing industry over digital goods,” Dan Wang, technology analyst at Gavekal Dragenomics, told the FT.

But while semiconductors have seen greater investment, investment in fintechs fell by 36% to $360m quarter-on-quarter. Investments in gaming companies fell by 96% to $21m, while e-commerce companies saw a drop of 54% to $4bn.

The semiconductor shortage looks set to continue well into 2022

The world is running very short on the supply of semiconductors, which are used in the manufacture of countless products. But demand has been outstripping supply; the Covid pandemic initially caused a drop in production for many industries, but drove demand for goods that thrived in a stay-at-home economy.

The shortage was made worse by a resurgence in Covid cases in the last couple of months in Asia casting further doubt on global supply chains.

With the shortage of chips likely to continue in 2022, it is hard to see the share prices of semiconductor companies falling in the next few months.

As Bloomberg puts it: “Global semiconductor-supply tightness, especially in mature-node chips, looks likely to extend to 2022. This would allow another round of price increases in 2H21.”

But with Chinese regulators as unpredictable as ever, there’s always the chance they will make a U-turn on some of their policies, and investors may flock back to the big Chinese tech and fintech names they are currently shying away from.

The investment world has reacted with horror to the idea that Chinese communist policy makers and regulators might not be enthusiastic about large private companies with too much pricing power.

The regulatory clampdown on online education platforms and tech giants such as Tencent and Alibaba has had an inevitable knock-on impact on the price of the leading UK-listed China funds.

The good news, however, is that all of the China-focused funds are underweight the tech giants compared with the weighting of over 30% in the MSCI China on 30 June.

In particular, Numis analysts note the “approach of Stewart Investors, manager of Pacific Assets, means that it has no exposure to the tech giants, which have not typically met the manager’s definition of quality”.

Rotating away from tech

Perhaps the biggest surprise, according to Numis, is the low exposure of Pacific Horizon – managed by Baillie Gifford – to these stocks given the group’s explicit focus on growth.

However, over the last 18 months the portfolio underwent a significant rotation away from Chinese tech towards more cyclical companies, including materials stocks, and exposure to India was increased.

The Numis analysts looked at funds’ returns between 22 July and 28 July, when market volatility peaked. The biggest falls came in JPMorgan’s China Growth and Income fund (down by over 12% in net-asset-value, or NAV, terms) with the Baillie Gifford China Growth and the Fidelity China Special Situations trusts not far behind.

The JPMorgan fund now trades at a 5% discount to NAV while its peers are still on premiums. As Numis observes, this is odd given “its exceptional track record through a growth approach in recent years”.

We may now be past the worst. Jimmy Chen, a manager based in Hong Kong for the Comgest Growth China fund, reckons that the market has overreacted to China’s recent regulations and that the Chinese regulatory environment has not actually undergone significant change.

Many of the new or rumoured regulations should have a limited impact, including those on property, food-delivery or the internet, with only private after-school tutoring (AST) companies being severely impacted. Chen also notes that there have been regulatory turnarounds before but what’s different this time is that “the new regulations have hit

some of the large-cap growth companies and sectors owned by foreign investors”.

If he’s right, some of the worst-hit stocks in the last few weeks are now cheap. Take Tencent, which has been getting a kicking as the regulators fret about the impact of video-gaming on the young. The share price has slumped by 40% from its January peak. That puts its shares on a price/earnings (p/e) ratio of around 20, which isn’t very expensive for a diversified internet conglomerate.

The negative scenario

So much for the optimistic take. But what if this regulatory drag net is just the beginning? Ollie Parsons of investment advisor Ravenscroft says that new sectors might find themselves in the firing line. Top of his list is healthcare; witness the 20% dip over two days in the Hang Seng Healthcare Index. According to Parsons, “it is no shock to see the healthcare stocks with a technology overlap being amongst the worst hit, stocks such as JD Health International and Alibaba Health Information Technology”.

He also reckons real estate could be in the firing line – again – as policy makers worry about rising property prices. If so, that could throw a spanner in the works of the next great potential China land grab by foreign investors: the real estate investment trust (Reit) market. Asia-focused fund manager Eastspring has suggested that the rise of onshore Reits was a big positive move, providing a new financing channel “for infrastructure projects from the public to the private markets. This new asset class will widen the range of long-duration assets available to Chinese savers and supplement pension and life insurance investments.”

New property investments

Chinese regulators are even contemplating commercial property Reits (offices, shopping malls, logistics and residential housing) which could rapidly become “a $3trn Reit market, overtaking the US, currently the world’s largest Reit market and far outpacing the rest of Asia”.

Which sectors are safe?

So what should investors do now? One option is to focus on the sectors where the Chinese communists are keen

to see increased investment, some of it foreign. Chinese-American venture capitalist and blogger Lillian Li runs an excellent blog called Chinese Characteristics, which looks at what works – and doesn’t – in Chinese tech.

She suggests that we should be looking at the current five-year plan for the sectors identified as key sources of future growth. These include new generation artificial intelligence, quantum information, integrated circuits (or semiconductors), neuroscience and brain-inspired research, and virtual reality.

Will GDP growth accelerate?

Finally, consider also the wise words of a Chinese-based American economist called Michael Pettis, who writes a widely read newsletter called GlobalSource. He’s regarded as the gold standard for macro-economic analysis in China and one of his latest notes suggested that we might expect much more pump priming to get

the Chinese economy moving even faster.

Pettis observes that “while I continue to expect China’s reported GDP growth for the year to be between 6% and 8%, I am starting to believe that it will be much closer to 8% than 6%. This is because there are signs that Beijing will allow investment in infrastructure and the property sector to pick up speed in the second half of the year.”

Frightening the bearers of global capital – and struggling with the Delta wave at the same time –

might give the government second thoughts about appearing too communist. If so, we may be able to look forward to a healthy rebound in the growth rate in the fourth quarter.

It has been a volatile few weeks for China, from regulators announcing crackdown after crackdown, to the country being forced to ease monetary policy.

But China is also grappling with a bigger issue: rising cases of coronavirus caused by the Delta variant.

This has prompted China to launch a fresh batch of targeted lockdowns, travel restrictions and mass testing once again.

So what is going on and what might it mean for the economy?

China’s Covid outbreak

China reported on Sunday 94 new locally-transmitted Covid cases, according to the National Health Commission. Further cause for alarm came in the form of 31 new imported cases, including eight in Shanghai, Guangdong, Yennain, and a handful in other cities including Beijing, Inner Mongolia and Sichuan, reports the China Daily.

While these numbers are strikingly low compared to the Delta experience in other parts of the world, the cases are still concerning. China came out of the initial pandemic relatively unscathed. Having been the first country to go into lockdown, it was also the first country to recover and enjoyed something of a V-shaped recovery.

The rise in cases now comes at a delicate time. It puts the recovery in doubt at a time when economic data shows that the world’s second largest economy was already struggling.

Data published over the weekend showed that Chinese exports grew by 19% in July year-on-year, below economists’ forecasts and significantly below June’s reading of 32%.

Indeed, at a time where most central banks around the world are talking about tapering or tightening monetary policy, China loosened policy last month by reducing banks’ reserve ratio requirements, making it easier for them to lend money.

My colleague John explained last month why China’s V-shaped recovery is a double-edged sword in a global economy and why it had to loosen policy.

To complicate things, factory gate prices (or producer prices), a key inflation measure, also rose in July. The rise came despite efforts by the country’s policymakers to prevent a commodity driven inflation.

What does this mean?

Producer price inflation (PPI) can be an early indicator of inflationary pressures. If factories have to pay higher costs for materials such as oil or metal, they will almost certainly try to pass these higher costs on to consumers, who in turn may demand higher wages.

Now of course, this is China and globally we’re still in the middle of a massive economic rebound. So we’re not talking about a recession here. However, the delta outbreak, among other things, has prompted major US banks such as Goldman Sachs and JP Morgan to downgrade their growth forecasts.

Goldman Sachs expects Chinese GDP growth to now come in at 8.3% in 2021, lower than a previous estimate of 8.6%. ”With the virus spreading to many of China’s provinces and local governments reacting swiftly to control the spread of the highly contagious delta variant, we have begun to see softening in national aggregate data.”

Goldman thinks that Chinese efforts to thwart the outbreaks will ultimately prevail and that growth will pick up in the fourth quarter. But in the meantime, will China’s decisions reverberate across all markets?

What exactly does it mean for investors?

The oil market certainly didn’t appreciate the news. The Brent benchmark shed as much as 4.5% on Monday as delta fears resurfaced. This is hardly surprising.

As Craig Erlam, senior markets analyst at OANDA puts it: “The fact that China is already importing lower numbers of crude, as well as other commodities like iron ore and copper, doesn't help the outlook or prices."

We have been through this cycle a few times already. Cases rise in some regions of the world, fear over growth rates spikes, and the more growth-sensitive markets (such as oil) wilt. As long as vaccines appear to keep working, then concerns over demand for energy products should be mollified.

That said, while 1.6 billion doses of vaccine are believed to have been administered in China, the country admitted earlier in April that local vaccines do not offer sufficient protection. So if hospitalisations and deaths continue to rise despite vaccinations then that could spell trouble for the global economy.

Central banks around the world have been pumping lots of money into their economies to keep them afloat during lockdowns.

Now that we are (hopefully) edging closer to the end of lockdowns, central banks have been murmuring about not printing as much money.

Or at least, that’s what most central banks have been saying.

But one rather important one has just loosened monetary policy yet further – the People’s Bank of China.

China’s economic recovery is bumpy rather than faltering

At the end of last week, the Chinese government – via the People’s Bank of China, the central bank – made it easier for banks to lend more money, by reducing the amount they need to hold in reserve.

To use the technical terminology, the Chinese central bank cut the reserve requirement ratio (RRR) for banks by 50 basis points (or 0.5 of a percentage point), starting from 15 July. In all that should enable banks to release another $150bn into the economy.

This rather stands out in a world where the rest of the major central banks are at least thinking about tightening monetary policy, not loosening it further. It’s also a little unnerving given that we’re meant to be having a rampant post-pandemic recovery.

If the world’s second-biggest economy is already needing to loosen monetary policy again, what does that mean?

Let’s try to unpack this and see if it’s anything we need to worry about.

Firstly, we need to remember that China went into this pandemic first and thus came out of it first too (notably before vaccines were developed, which is something we seem to be forgetting as we discuss our own release from lockdown).

So China has had a V-shaped recovery spurt. Now the recovery is slowing, and more quickly than many analysts had expected. This could at least partly explain the recent dip in commodity prices.

However, before we go too wild in terms of extrapolating this to all the other “V-shaped” recoveries across the world, it’s also worth remembering that China’s “first in, first out” status is a double-edged sword in a global economy.

It’s like trying to organise a party when all of your friends are stuck quarantining. Things might be fine in your house but your party isn’t exactly going to be raging when no one else can come.

Also, as Eoin Treacy points out on FullerTreacyMoney.com, a slowdown might also just reflect a drop in “demand for products associated with lockdowns” as other countries start to emerge from the pandemic.

The other thing about V-shapes is that they represent short, sharp rebounds. Once the rebound bit is done, the V-trajectory starts to turn into something else. That doesn’t mean it’s all over.

So it’s easy to read too much into these things, and as far as the global economy goes, I think there are just too many variables influencing the data. It’ll take a while before we see how this all turns out, and in the meantime, I still believe that logic suggests an overall arc pointing in the direction of longer-term strong recovery (with a lot of bumps along the way).

Yes, but why is China making lending easier?

So why is China cutting the RRR? As Julian Evans-Pritchard of Capital Economics points out, this is not necessarily a broad-based loosening of monetary conditions. “It is partly intended to offset tightening elsewhere”.

It’s more about shuffling the focus towards the more fragile parts of the Chinese economy and financial structure, “including the balance sheet weakness of highly-indebted firms”. In effect, it’s aimed at encouraging banks to cut borrowing costs for companies that might otherwise run into trouble.

As you’ve probably noticed, commodity prices have been spiking, or at least they were in the earlier part of the year. That’s put companies under pressure in terms of rising costs. So one argument is that, as Morgan Lau of Fidelity International tells Bloomberg, “the primary motivation for China is to support small and medium companies influenced by the spike in inflation”.

Meanwhile, China is trying to mature its financial system and make it more resilient and deeper. That involves making the system a bit more capitalist (ironically enough). This is why increasing numbers of companies have been allowed to go bankrupt.

If China wants to compete with the US on the economic and financial markets stage, it doesn’t have much choice other than to keep doing this. As Diana Choyleva of Enodo Economics describes it, China needs to “professionalise its capital markets”. But it also wants to maintain control over everything.

More than anything else, that means no sudden moves (notwithstanding the attempts to bring Didi to heel after it decided to list in the US in the face of opposition in China).

So overall, this looks like a move designed to ease potential strains in the system rather than evidence of something more serious (as yet). But it’s worth keeping an eye on. In any case, markets liked the move - they tend to like any sign that authorities might want lower rates.

And perhaps that’s the main thing to take from this right now. Markets seem nervous about growth or the recovery faltering. But China has just shown us what the response will be if it does: immediately reach for the rates lever. And until inflation makes it genuinely politically painful to do that, that’ll be the solution reached by central banks across the globe.

Anyway – if you’re in the mood for some thought-provoking big picture analysis on what you should really be worried about when it comes to China, listen to our latest podcast, where Merryn talks to historian Niall Ferguson about China, Taiwan and the US, among other topics.

Before I get started today, we’d love to know a bit more about how you invest and where your interests lie. If you could take 15 minutes to fill in this survey we’d be much obliged – you might even win a £1,000 Amazon voucher!

Today we turn to China, and a big bad bank that has been rattling credit markets over there. China Huarong Asset Management is a financial company backed by the Chinese state. It was set up in the late 1990s as a “bad bank”.

A “bad bank” is a dumping ground. It buys up toxic assets from other banks to help them to clean up their balance sheets. The bad bank then gradually processes these assets one way or the other, over time (some toxic assets turn good, others will just default and be worth nothing).

The point is to isolate and enable a managed run-off of dodgy assets, in order to prevent a systemic meltdown or to help with the recovery in the wake of one. In this case, Huarong was part of a clean-up of bad loans that followed the Asian financial crisis of the time.

The group went on to do a lot more than just buying and restructuring bad debt. Lai Xiaomin took charge as chairman in 2012 and expanded Huarong into other areas of finance including investment banking and property. In 2015 it listed in Hong Kong, attracting plenty of big international investors.

But then Lai fell from grace. He was arrested in a crackdown on corruption in 2018. He was found guilty of taking bribes in January this year (and also of bigamy, incidentally). He was executed shortly afterwards.

Of course, this cast something of a shadow over the company. As Bloomberg reports, “at Huarong, the bottom has fallen out. Net income plummeted 95% from 2017 to 2019”. Combine that with all the low-quality lending that also apparently went on under Lai, and you have a recipe for trouble.

And that’s what appears to be coming to a head now. Huarong warned earlier this month that its 2020 results would be delayed. This week, fears grew that the company was planning a big restructuring. More importantly, speculation in the Chinese press suggested that it might even end up going bankrupt.

That clearly would not be good news for anyone holding any of the roughly $23bn in dollar-denominated debt outstanding. The value of that debt fell sharply at the start of this week.

You might wonder why this has only now become an issue. It’s pretty simple though: everyone knows that bad debt is a problem in China. And in recent years some state entities have even been allowed to default on their debts.

But the assumption has always been that the Chinese state would always bail out a big, systemically-important state-controlled enterprise like Huarong. As a result, foreign investors have been happy to lend them money.

As Bloomberg quotes one analyst as saying, “a default at a central state-owned company like Huarong is unprecedented”.

So is it likely to happen now? And why is it more widely relevant?

In the long run, allowing more defaults is good news

In terms of what happens with Huarong, it’s not anything most of us need to worry about as investors. You almost certainly don’t own the bonds and it’s unlikely to have a huge impact on anything you do own.

And even the owners of the bonds don’t seem likely to take too big a hit. Most analysts seem to think that Huarong matters too much and that a full-on default might trigger a chain reaction, which the Chinese state would of course, want to avoid.

So a restructuring is more likely, whereby perhaps another bad bank is created to take the bad assets from the original bad bank, as analysts at Gavekal point out. And while international bond investors might have to take a “haircut”, it won’t be “so big that it inflicts longer term damage on investor confidence”.

In the longer run, the fact that China is trying to encourage a bit more discrimination in terms of lending is a good thing – just because bad debts can be hidden in a financial system doesn’t mean that there aren’t consequences.

Tight control means that you might not get a “Lehman Brothers” moment. But if you keep throwing money at unproductive projects and borrowers who can’t pay the money back, that’s going to hurt your economy.

As Freya Beamish of Pantheon Macroeconomics points out, “officials are well aware that China cannot afford any further build-up of bad debts, precisely because the economy is already vulnerable from this perspective.” Hence the decision to steadily allow more defaults.

But it’s a tricky balancing act. As Bloomberg reports: “Chinese authorities have tried to strike a balance between instilling more market discipline and avoiding a sudden loss of confidence that might spiral into a crisis.”

The bigger issue in the shorter term for the average investor might be that efforts to get rid of some of this bad debt (and avoid more building up) may have an effect on economic growth in China.

That’s more significant given China’s importance to global growth overall. For now, it doesn’t look like being a problem (although note that while China’s GDP growth bounced back in the first quarter of this year, it actually missed expectations).

But it’s another risk to keep an eye on, and no doubt one we’ll be writing more about in the near future in MoneyWeek. If you’re not already a subscriber to the magazine, you can get your first six issues absolutely free here.

What’s happened?

Last month China’s ultimate decision-making body, the Standing Committee of its rubber-stamp Parliament, passed sweeping reforms that further strengthen Beijing’s tight political control over Hong Kong. The measures slash the proportion of elected seats in the territory’s legislative assembly from 50% to 22%, and require all would-be MPs – as well as all other public officials – to be vetted for their “patriotism” by a pro-Beijing committee. The move prompted a further wave of arrests and convictions of dozens of pro-democracy politicians and activists. One of seven people convicted last week – over a peaceful demonstration in 2019 – was Martin Lee, the 82-year-old barrister known as the “father of democracy”. Lee once helped draft the Basic Law that underpinned Hong Kong’s relative freedoms after 1997. He now faces up to five years in jail for unlawful assembly.

So it’s now “one country, one system”?

It’s certainly a further decisive step on the road to a Hong Kong that is much more tightly integrated into mainland China – both politically and economically. The convictions of both Lee and media magnate Jimmy Lai are likely to set a precedent for several upcoming trials on similar charges of illegal assembly and protest. The year 2019 saw a wave of street protests and sit-ins in Hong Kong sparked by anger at a new law making its citizens liable to summary extradition to the mainland. Last year, Beijing forcefully signalled its patience was at an end and imposed a wide-ranging new national security law on Hong Kong, aimed at eradicating “splittism, subversion, terrorism, and any behaviour that gravely threatens national security and foreign interference”. In effect, it’s an anti-sedition law that gives Beijing very broad, greater powers to stifle dissent, and it’s the first time that a mainland criminal law has been introduced into Hong Kong’s semi-autonomous legal code.

What about economic freedoms?

The Hong Kong government has long taken pride in the perception of its economy as one of the most liberal and open in the world – an international business hub with low tax rates and open ports. For 25 years it topped an “Index of Economic Freedom” published by the Heritage Foundation, a conservative US think tank, though last year it slipped to second place after Singapore. A few weeks ago, however, the Foundation took Hong Kong (and Macau) off its list completely. The move amplified the sense that the territory’s status as a global financial hub is now in real peril.How important is Hong Kong?

Hong Kong is crucially important to global markets as a key Asian financial hub and a unique conduit between China and the West. Last year the Hong Kong Stock Exchange ranked as the world’s second largest initial public offering market, raising a total of HK$389.9bn (£36bn) from 140 listings, according to KPMG, and beaten only by New York’s Nasdaq. In 2019 around US$10trn of US dollar transactions flowed through its bank-to-bank payments system. Some 420 hedge funds (80 more than Singapore) are based there, managing more assets than Singapore and Japan combined. It’s home to the global or regional HQs of 1,500 international firms. And, crucially, it is by far the pre-eminent dollar-funding centre in Asia.

Is it fading as a financial hub?

There’s no sign of that yet, and a surge of global capital seeking to reach Chinese markets has drawn even more investment to Hong Kong over the past year. In a long-established annual survey of global financial centres, updated last month, Hong Kong actually climbed a place from fifth to fourth, behind New York, London and Shanghai. Singapore came in fifth and Beijing sixth, while Tokyo dropped three places from fourth to seventh. The Global Financial Centres Index (GFCI) report cited the popularity of Hong Kong’s stockmarket for new listings, as well as the many cross-border trading schemes with the mainland, as key reasons for the territory’s ranking.

So nothing to worry about?

So long as Hong Kong retains a stable business environment, the free flow of capital, low tax rates and a reliable legal system based on English common law, it’s likely to keep its status as a global financial centre. But if the US were to target the dollar-payment system, or China’s communist party to destroy the independence of Hong Kong’s courts, judiciary and financial regulators, Hong Kong’s allure could fade fast. Moreover, Hong Kong is gradually becoming a centre of Chinese finance, rather than a global one. The share of mainland firms listed on its stockmarkets has risen fast, now accounting for 75% of overall market capitalisation. Last year more than 2,000 mainland mutual funds invested in Hong Kong, a jump of 268% in a year. And Chinese investors brought in net inflows of HK$672bn (£63bn) through an investment channel called “stock connect”, 170% up on the year before.

Will anything change?

Beijing is clearly betting that Hong Kong’s role as an Asian financial centre will mean it remains attractive to Western financial institutions, whatever their governments have to say. Any change is likely to be gradual and its importance as a gateway into China will remain, barring some big upset. Justin Tang, head of Asian research at United First Partners, says most banks with a presence in Hong Kong will also have a base in Singapore, but doubts that a sudden exodus is imminent. “Unless we see something really drastic in China, Hong Kong, the likes of what we are… seeing now on the streets of Myanmar, it’s going to be a slow burn if it’s going to happen,” he told The Daily Telegraph. Beijing is determined to rebuild Hong Kong, says The Economist, “The old Hong Kong is gone. Judge Xi’s China by what it builds in its place”.

SEE ALSO:

Hong Kong’s brain drain

China has surpassed the US as the world’s leading recipient of new foreign direct investment (FDI), say Paul Hannon and Eun-Young Jeong in The Wall Street Journal. The US had held the FDI top spot “for decades” but last year saw inflows plunge by 49% amid the pandemic, while China’s advanced 4%.

FDI is a measure of direct business investment rather than financial market flows. For all the talk of decoupling and shifting supply chains, big multinationals are still ploughing money into the country, with Starbucks spending $150m on a coffee-roasting plant and AstraZeneca setting up a network of regional offices.

China’s latest financial liberalisation effort, meanwhile, is in commodity futures. China is the world’s biggest consumer of iron ore and copper but most prices are still set on exchanges in London and Chicago. Regulators recently launched a yuan-based copper futures contract that has attracted strong interest from overseas traders. It is easy to see why Western investors are keen, says Michael Mackenzie in the Financial Times. The local ten-year government bond yields 3.1%, far more than its developed-world counterparts. The local CSI 300 stock index gained 27% last year and is already up 4% in 2021. Investors are also being seduced by the growth outlook. China was the only major economy to grow last year, adds Freddie Hayward in the New Statesman.

“There are lots of reasons why investors should have exposure to China”, says George Magnus, of Oxford University’s China Centre. But “a lot of good news is already” priced in. Nor is the geopolitical backdrop encouraging, despite the departure of Donald Trump. China is still set to face a “hostile global environment”.

China is “by far” the world’s “best-performing big economy” this year, says The Economist. GDP grew by 3.2% in the second quarter compared with a year before. A recovery is now well under way following a 6.8% fall in the first three months of the year. Economists treat China’s GDP statistics with justified scepticism, but “alternative indicators” such as coal consumption and traffic congestion tell a similar story.

The recovery is being led by manufacturers, says Jonathan Allum in The Blah! newsletter. Industrial production rose by 4.8% year-on-year in June, but retail sales undershot expectations, registering a 1.8% contraction. That makes this recovery dependent on selling products into world markets, not ideal at a time of weak global demand and a growing backlash against imports from overseas. “How much kit will Huawei [export] to the UK in the future?”

The GDP figures have been flattered by a “massive surge in metal-bashing for infrastructure projects”, agrees Ambrose Evans-Pritchard in The Daily Telegraph. Much of the funding is being channelled through “chronically inefficient state-owned enterprises” that don’t respond to market signals. China seems to be repeating the mistakes of its massive post-2008 stimulus, which saw vast amounts of ill-targeted infrastructure spending push the economy into a “debt trap”.

The Institute of International Finance’s Global Debt Monitor reports that total debt in China across households, governments and corporations started the year at just over 300% of GDP, but is now “fast approaching 335% of GDP”.

The backing of a one-party state means that China’s debt bubble is very unlikely to pop, writes Mike Bird in The Wall Street Journal. But that doesn’t mean it does no harm. Research shows that misallocation of capital – especially into the bloated housing sector – acts as a slow-burning drag on productivity. With GDP per capita of $10,262, China has miles to go before it catches up with advanced economies. Overinvestment in real estate won’t help.

Cooling the rally

The positive data has made it easier for the authorities to tout a “healthy bull market”. The CSI 300 is now up more than 12% for the year-to-date. Retail investors make up 80% of trading, so sentiment rules the roost. The surge has brought back “bad memories” from 2014-2015, says Craig Mellow in Barron’s. Domestic shares “more than doubled in seven months” before losing 40%. Yet regulators seem to have learnt their lesson, moving to tighten margin requirements to cool the euphoria. That means this rally may not have much further to run. But in the long-term Chinese markets could become less of a roller-coaster ride.

What has happened?

At the end of last month China’s rubber-stamp parliament, the National People’s Congress, approved a new draft national security law for Hong Kong. The details have yet to be published, but its stated aim is to prohibit “splittism, subversion, terrorism, and any behaviour that gravely threatens national security and foreign interference”. It would be the first time that a law from the mainland, carrying criminal penalties, has been introduced into Hong Kong’s semi-autonomous legal code. Hongkongers would have no say in the matter and the law (it is widely feared) would end the independence of Hong Kong’s judiciary. As such, many Hongkongers believe it would kill off the “one country, two systems” model that has protected the territory from the worst aspects of Beijing’s authoritarianism since 1997.

What’s the background?

From last June until the onset of the coronavirus crisis in January, Hong Kong was gripped by violent protests over an extradition law (since withdrawn) that many feared would be used by Beijing as a tool to suppress dissent. The new proposed law, it is widely presumed, would be far worse – facilitating the mass arrest of pro-democracy campaigners on trumped-up political charges, and giving free rein to the mainland’s security forces to crush dissent. It’s not yet known exactly how the law will be framed, but it’s hard to avoid the conclusion that it will harden positions on both sides, leading to deeper civil unrest. The new law means that Hong Kong “could be a simmering centre of revolt for years”, says James Palmer in Foreign Policy. “This summer could see violence – mostly at the hands of the police, but some by protesters – on a scale that dwarfs last year’s protests.”

How will that affect business?

The US response to the law – to declare that it will no longer treat Hong Kong as a meaningfully autonomous territory – has amplified the sense that the territory’s status as a global financial hub is now in real peril. The underlying purpose of the national security law is to accelerate Hong Kong’s absorption into mainland China, whereas the great attraction of the city for global businesses is that it provides a bridge into China – but with financial and legal systems that are far more transparent and credible. That’s a tension that may ultimately be impossible to resolve. And on a practical level, the prospect of increased security issues and ongoing chaotic protests make it a much less attractive place to live for wealthy foreigners – not to mention the prospect of potential arrest on vague national security grounds (like the two Canadians held by Beijing since 2018 in retaliation for the arrest, in Canada, of Huawei’s Meng Wanzhou).

How important is Hong Kong?

It’s the world’s third-biggest financial centre, after New York and London. And as global power and wealth pivots towards Asia, Hong Kong is crucially important to global markets as the biggest Asian financial hub, and a unique conduit between China and the West. Already Hong Kong has the fourth-biggest stockmarket in the world (bigger than London’s), listing nine of China’s ten biggest companies and international ones, too (though the proportion of mainland firms has risen fast in recent years, now accounting for 75% of overall market capitalisation). Crucially, Hong Kong is by far the pre-eminent dollar-funding centre in Asia. Some $9.7trn of cross-border financial claims, such as loans, are booked in Hong Kong. And around $10trn of dollar transactions flowed through its bank-to-bank payments system last year. Some 420 hedge funds (80 more than Singapore) are based there, managing more assets ($91bn) than Singapore and Japan combined. It’s also home to the global or regional HQs of 1,500 international companies.

How are they reacting?

Some banks are busy negotiating a very delicate tightrope. Last week HSBC (UK-listed but founded in Hong Kong in 1865) and Standard Chartered bowed to pressure from China to say they supported the security law; as a result they have faced opprobrium from politicians and commentators in the UK. “Yet the idea that international banks such as HSBC and Standard Chartered can publicly defy the laws of the countries in which they operate, and still expect to thrive, is naive in the extreme,” says Jeremy Warner in The Daily Telegraph. Meanwhile, behind the scenes, many global banks, fund managers and financial services firms have been quietly examining exit strategies for months, says George Hammond in the Financial Times. Hedge funds are being discreetly induced to relocate by the like of Singapore and Tokyo.

What will happen?

Although the Hang Seng stock index fell following China’s announcement, for the time being there’s no sign of capital flight. Investors are reassured by Hong Kong’s $440bn of foreign reserves and long history of stable financial management. In terms of Hong Kong’s future as a global hub, much will depend on how the fracturing relationship between the US and China evolves. But for now there is no sign of the US resorting to its nuclear option – imposing sanctions or restrictions that would stop Hong Kong officials, banks or firms from using the dollar. Yet plenty of executives at mutual funds, multinationals and banks are mulling relocating away from Hong Kong. For them, there will be two key measures to assess as the security law is imposed, says The Economist. First, will the US target the dollar-payments system, “which has the potential to cause an immediate scare”. And second, will the communist party attempt not merely to suppress dissent and intimidate foreign critics, but also to compromise Hong Kong’s institutions – its courts, independent judiciary, central bank and financial regulators. “If it fails these tests, its time as a global financial centre really will be up.”

SEE ALSO:

Hong Kong’s brain drain

Is China a safe-haven? Stocks in the country where the coronavirus originated have dodged the worst of the falls on Western indexes. The Shanghai Composite index is down by less than 10% since the start of the year, compared with 29%-33% losses in the US and Europe.

China is gradually getting back to work but with tough restrictions, say Ryan McMorrow and Qianer Liu in the Financial Times. Employees often have their temperatures taken multiple times per day and most companies are only allowing about half of their workers back into the office. Compulsory face mask wearing remains common.“Halting the world’s second-largest economy has proved easier than restarting it,” writes Keither Bradsher in The New York Times.

Most factories have reopened but are operating at two-thirds of their capacity, while tens of millions of workers remain in quarantine or stuck in other towns. Early data hints at the severe impact of the country’s “vast containment efforts”. Industrial production, retail sales and investment all dropped by double-digits during the first two months of 2020 compared with a year before.

China may now be on course for its first quarterly contraction since 1976. This week Goldman Sachs predicted a 9% plunge in first-quarter economic activity in the wake of the shutdown.

“Investors seem to be betting that the crisis in China is mostly over,” says Jacky Wong in The Wall Street Journal. The “relative isolation” of the country’s financial system has also insulated its stocks from the global sell-off; just 2.1% of equities are in foreign hands.

Yet that optimism appears misplaced. The disease may yet flare up again as restrictions are relaxed. As the world’s largest exporter China cannot dodge the incoming global demand hit as other countries bring in lockdowns, nor supply chain disruptions coming from abroad. China may have contained the epidemic for now, but “the economic consequences will... continue to widen”.

Could the Covid-19 shutdown have put China on course for a “secret recession”? asks Tom Rees in The Daily Telegraph. Freya Beamish of Pantheon Macroeconomics predicts an “unprecedented” 0.9% quarter-on-quarter GDP fall. GDP expanded by 6.1% last year, but there are persistent questions about the official figures. The true impact of this outbreak will “be a closely guarded state secret”.

“It is hard enough to understand China’s economy and its global ramifications at the best of times,” says Ambrose Evans-Pritchard in The Daily Telegraph. Those banking on a stimulus-led rebound later this year must first wait for the outbreak to be contained. Meaningful fiscal stimulus is impossible so long as the spending channels are blocked by health curfews and factory closures.

“It is hard to overstate” the economic impact of the current shutdown, says The Economist. Chinese coal consumption is more than a third lower than normal; factories are shut or running at low capacity in provinces accounting for more than 90% of exports. The global economic impact could be severe. Unlike during the 2003 Sars outbreak, China’s factories are today enmeshed “in supply chains of mind-boggling complexity”. The closure of a factory in Wuhan could have consequences for a manufacturer in Stuttgart and a retailer in Michigan.

Evidence of an impact on neighbours has already emerged, says Neil Shearing of Capital Economics. Korean imports from China fell almost 50% year-on-year in the first ten days of this month. The coronavirus will prompt more multi-national businesses to question the wisdom of complex supply chains. We are already living in an era of deglobalisation in the wake of Trump’s trade wars. The Covid-19 outbreak will only accelerate the tre

Hong Kong is starting to resemble a “failed state”, says Clara Ferreira Marques on Bloomberg. There is “palpable anxiety” in the coronavirus-hit city, where a bungled official response, shortages of masks and toilet-paper panics remind me of Russia during the “chaotic summer of 1998”. A failing state is one that cannot protect its citizens, provide basic services and command the trust of its people. With the city reeling from anti-government protests, it “is ticking most of those boxes”.

The city is failing to provide the safety and stability that a global financial centre needs. The contrast with Singapore is stark: the prognosis for Hong Kong’s “future as a financial hub looks poor”.

Last year’s protests and a sharp decline in tourism had already pushed Hong Kong into recession, with GDP contracting 2.9% year on year in the final quarter of 2019. Now the coronavirus epidemic is making things even worse. UBS bank analysts predict a year-on-year fall of over 6% in the first quarter of this year, says The Economist. The local Hang Seng stock index is down more than 3% since 1 January and property prices are 5% below their peak. The risk now is that “speculative capital might quit the market and the city”. Falling property prices would put pressure on the banking system.

Meanwhile, the loss of international and mainland visitors is inflicting a “double devastation” on local retailers, notes The Guardian. While the number of coronavirus cases in Hong Kong is relatively low for now, a more serious epidemic risks triggering a Wuhan-style lockdown. Macau and Thailand, where Chinese arrivals account for 2.7% of GDP, are also vulnerable, says Trinh Nguyen of Natixis. Other economies in Southeast Asia with significant Chinese tourist traffic include the Philippines and Vietnam.