YWR: The #1 Trade
Part 1: China as a robotic vacuum cleaner
100% Tariffs on Chinese EV’s. Seems like another ratcheting up of the trade wars.
Except, I think it’s much bigger. I think it’s the straw that breaks the camel’s back.
Put yourself in Xi’s shoes.
Decades of being told China is dirty. Chinese cities are polluted and nobody can breathe. China is ruining the environment and causing global warming. Chinese goods are cheap but dirty, etc, etc.
So you flip everything around and become a global leader in all things green energy. You are the leading producer of solar panels, wind farms, batteries, and electric vehicle adoption. And now your world leading industries would like to sell these products in other markets. As would any business. Everyone should be happy right? Everyone should be praising you for cleaning up, saving the world and helping with the clean energy transition.
Nope. Now you are risking American jobs. Bad.
If you are Xi you realise it’s a lose, lose situation. Dammed if you do. Dammed if you don’t. And the EV tariffs illustrate this more than anything else because there is no national defence angle to it like semiconductors. EV’s are supposed to be something everyone would welcome. But no. Both the US and Europe are shutting you out.
And if you are Xi sipping some green tea in a silk robe in Beijing you realise your business model has a problem.
You are an export driven economy, the world’s factory, but your two biggest customers (Europe and the US) don’t like you, don’t want your products and are trying to shut you out. And you don’t really like them much either. But you try to keep your mouth shut and not insult them, but it’s increasingly difficult.
And as Xi sips his tea, admires the garden and thinks about the future he see 3 paths forward.
Path 1: Death by a Thousand Cuts.
This path is more of the same. Try to stay on the fence. Try to grow China and undermine the US and Europe with Belt and Road, BRICS, and UN votes, but never cross any red lines.
The problem is these Global South countries don’t have any money. The guys with the money who can buy Chinese goods are the Europeans and Americans, but they are continually chopping away at you.
Even your own Chinese businesses want to leave and move to Mexico, or Morocco, so they can export into Western markets. Effectively, you are no good to anyone. Your domestic consumer is stagnant and being ‘Made in China’ has turned into a liability.
Meanwhile, the US seems to be going from strength to strength. You were supposed to have passed them by now, but now it is you who are stuck in the mud. This wasn’t supposed to happen. This path isn’t working. Something has to be done.
Path 2: Bend a Knee
Maybe it’s time to give up on the dream of China being the #1 world power. Maybe the US is the Empire and it’s time to just accept it and join the dark side. Stop fighting it. Be like Japan, South Korea, Taiwan or Singapore. They are happy. So accept the US as your Emperor and bend a knee. Kiss the ring. It will be OK. You can still be a dictator and do what you want within reason. You just have to follow US policy when asked. China gets access to US and European markets again, the economy starts to grow and the people are happy.
But gawd… did you really work this hard and come this far to become just another Japan or South Korea?
And being a cog in the US empire isn’t true to your nature. It wouldn’t work.
Xi ponders this dilemma…. there is always the 3rd path.
Path 3: China as the new America
In a way Biden and his EV tariffs are symptoms of a bigger problem. The fact is China has outgrown the US and Europe as export markets. Yes, that model works for smaller countries like Japan, South Korea and Taiwan, and it has worked well for China to a point, but now China is too big. And that is why it is bumping up against so much resistance.
The next phase requires something new.
The reason the US and Europe have so much power to decide things globally is they are the customer. And the customer is always right. If they don’t like you they can always cut you off. Which is what’s happening right now. And the other thing that goes with being the global customer is reserve currency status.
If China wants to have the power, China needs to be the customer. China needs to be the market the whole world revolves around, not the US. The RMB needs to be the currency everyone has to have.
China needs to grow its domestic consumption. China needs to be the new US.
But it’s going to require swallowing a few bitter pills.
And it requires playing the long game.
But that’s OK Xi thought. He was good at that.
It would require loosening up control of the RMB. It would require some domestic reform of the Hukou system. And it would also require being nice to US companies and luring then back into China. He needed them to invest. The whole world should want/have to come and invest in China.
The whole tone would have to change. He couldn’t have his security forces harassing the foreign CEO’s all the time. He would have to sweet talk these CEO’s and lure them back. Xi decided he would make a first step and meet with some of the CEO’s currently in town.
Then 20 years from now. When China was the biggest economy in the world. When every US company depended on China then he could drop the hammer. Then he could reshape the world. A world with Chinese characteristics. And maybe the Taiwanese would finally see where their bread was buttered.
China as the robotic vacuum cleaner
I’m having fun with the idea of Xi figuring out his grand plan while sipping tea in a garden. But the reality is China’s CCP is more like a robotic vacuum cleaner.
You know when they get stuck under a chair and can’t figure the way out so they just keep bumping into things? That’s China right now. They are bumping around changing directions slightly and then bumping into another wall as the algorithm keeps trying to find the way out. Meanwhile, you are standing there looking at it and can see the way out. You can see how if it just changes direction there is an expansive blue ocean. But it keeps bumping away. Eventually it will figure it out. It always does.
Part 2: Economic Ramifications of China as the New US.
China has some of the highest savings rates in the world. Because China is under consuming and running record trade surpluses, these excess savings end up invested in US assets (Treasuries). The reciprocal of a large trade deficit is a capital account surplus. Somebody has to lend you/invest the money for your consumption.
If Chinese households are incentivised to spend more of these savings it’s a new driver of economic growth and swings the capital account the other way.
In 2023 Chinese GDP was $17 trn and US GDP was $27 trn. With a more domestic driven economy I forecast that by 2030 Chinese GDP could be $28 trillion and US $38 trn. Still a $10 trn difference but on a % basis the gap is closing.
I am trying to forecast actual nominal numbers because these are the numbers which will be reported in the real world, ‘not inflation adjusted’, or, ‘at constant purchasing power parity’.
What you see with 3% inflation is the GDP numbers for both countries climb rapidly. It’s the Zimbabwe effect. I have built in an 18% appreciation of the RMB vs the $ based on the inflation differential (lower inflation in China), which helps China close the gap with the US, but China still doesn’t catch the US. This was an interesting insight for me. Maybe the RMB appreciates more.
The more important shift is what might happen to the trade deficit. If Chinese imports grow in line with domestic consumption and exports grow more slowly due to tariffs and currency appreciation, you get a swing from a trade surplus to a trade deficit. By 2040 this could be an $800bn deficit. A mirror image of today’s $800bn surplus.
Let the chart above sink in. I know it seems impossible. But I’ve shown you why it makes sense for China to allow this to happen and how it mechanically happens if imports keep outgrowing exports for a long period of time.
China can still be the leader in global high tech, still be a leading manufacturer, but becomes the most important consumer market too.
Appreciate how that trade deficit chart changes everything, everything for the economy, global politics and your portfolio.
Part 3: The #1 Trade
The #1 trade is you gotta be bigger in China. If you are a MegaFund get bigger in everything. Chinese property, China equities, China private equity.
Everyone is at 5% China or less. Norges, the biggest SWF in the world is at 2%.
Look. I’m not in love with China. But I respect China. I respect what they have accomplished and what they can do in the future.
What I’m in love with is making money and catching new trends when they’ve barely started. You are catching China on the lows at historically attractive valuations and that’s super interesting. That’s why China is the #1 trade.
And think how much more fun it would be to go and hoover up $1bn of distressed China property when nobody is paying attention instead of waiting in line to buy a wind farm.
For now China’s extreme valuations are enough to make money. But in the years ahead I expect the consumption story will become more evident and give us second and third legs to the trade.
Interesting annecdote. You know who is coming around on China? Mrs YWR. Previously, we couldn’t invest in China. Now she thinks the US is acting like a bunch of idiots and China is going put their head down, outwork us and take over. Our daughter’s school is 70% Chinese students and she sees how hard they work, and how they are in the library util 11pm and never want to go to the pub. Now she says it is OK to own China stocks.
Part 3: How I am Playing it and a new Cash Dragon model
Here is how I’m building up my China exposure.
I built a third Cash Dragon model and added it to the Data and Models section of www.ywr.world