The Contrary Case on China

Nov 2, 2023

The pessimism on China is well in excess of anything I have encountered in my 25 years as a China watcher. There are a few scattered holdouts but even I threw in the towel nearly a year ago after being pretty much of a perma-bull on China since the late 1990s. But where ever I go (except China, of course) and whatever I read, the consensus view on the Chinese economy is now beyond bleak.

The contrarian in me has seen too many one-sided bets in the past that have turned out to be wrong. I won’t list them, but I am reminded of the fabled “curse of Lyford Cay.” Morgan Stanley used to have an annual investment conference at this famous Nassau resort. It was a small conference of about 40 investors, but it attracted the crème de la crème of the “smart money.” The final day of the conference was a roundtable where each of the participants offered up their three best investment ideas.

Byron Wien, my erstwhile partner who sadly passed away last week, would tally the picks and then identify the key investment themes of the year. And as luck would have it, the group was invariably wrong on the big themes, badly wrong. Could that now be the case on China?

The negative view of the Chinese economy is not lacking in solid arguments. The November/ December issue of Foreign Affairs provides a compendium of arguments supporting the notion of “peak China.” From Adam Posen and his focus on the political economy of a failed autocracy that was glaringly apparent during the Covid crisis to Michael Pettis who has long warned of China’s structural imbalances, there doesn’t seem to be a way out. For what it’s worth, my own view leans more toward Pettis, with emphasis on the headwinds to Chinese productivity growth that will make it exceedingly difficult to overcome the now chronic drag from a shrinking working age population. While I don’t believe that China is the “next Japan,” there are plenty of worrisome Japanese-like characteristics to China’s long-term growth problem.

So how could I and all the others be wrong? This is an important question that I learned long ago on Wall Street. It is critical for an analyst, a strategist, or an economist to understand the other side of their deepest convictions. As for the bull case for China, the possibility that intrigues me the most is the subject of my latest book and the essence of what I have been blogging about in this space over the past 16 months—the US-China conflict. Conflict resolution certainly won’t fix all that ails the Chinese economy, but I believe it will go a long way in shifting the pendulum of economic policy away from the zero-sum paranoia over national security back toward pro-growth fundamentals.

There are three reasons why this would be important for China in solving its growth problem: First, ending the trade war would allow the now beleaguered Chinese export machine to draw more freely on external global demand. Second, ending the tech war would allow China to draw on advanced foreign technologies to boost indigenous innovation and productivity. Third, rebuilding trust would reduce the “de-risking” fixation by both nations to counter alleged security threats; if that were to occur, then the US and its allies, who claim to have no interest in decoupling, would end the destructive supply-chain diversion that is severely hobbling China.

Wishful thinking? Absolutely so, at this point in time. But with Presidents Biden and Xi now actively engaged in preparation for their upcoming San Francisco summit, it might pay to keep the contrary possibility in mind. Could the two leaders collectively pull the metaphorical rabbit out of a hat? As the crescendo of negativism builds on the Chinese economic outlook, conflict resolution might well work magic.

You can follow me on Twitter @SRoach_econ

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