Global Market Commentary

Who Is Going To Be The Leading Global Power by 2050?

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Chinese As A “Leading Global Power” by 2050 — And How China’s Tech Giants Feature In That Equation

With Chinese internet stocks “as hot as the sun” according to one commentator, companies such as Alibaba [NYSE:  BABA], Baidu [NASDAQ:  BIDU], Tencent [Hong Kong:  700], [NASDAQ:  JD], and TAL Education Group [NYSE:  TAL] have received a lot of attention in financial media.

Headlines about China have also focused on the recent Communist Party Congress in Beijing.  This congress, held every five years, is the venue for leadership changes and for review and recalibration of party policy at the highest levels.  China’s increasing economic and geopolitical clout on the world stage has meant that global observers and analysts give it a lot of attention, attempting to discern what it may mean for politics and for the markets.

This was the 19th Party Congress.  Odd-numbered congresses typically set the stage for more major leadership changes at the subsequent even-numbered congress — elevating officials and setting the stage for transfer of power at the highest level.  In the recent appointments, there are no clear successors to President Xi.

Newly Minted Members of the Politburo Standing Committee:  No Challengers For President Xi

Source:  Caixin

The ongoing enthusiasm for Chinese internet stocks and the events of the recent party congress are related.  They tell the same story: an inflection point in Chinese technological capabilities and culture of innovation — and in the intention to use those capabilities to increase China’s global standing and global power.

          China’s Rise: What Not To Fear

A great deal has been said about China’s economic and geopolitical rise, and about what that rise means for the global hegemony of the United States and its allies, and we think much of it is alarmist.

For example, there has been a more or less constant discussion in recent years about the rise of a multipolar global financial order, in which the Chinese yuan challenges the U.S. dollar as a global reserve currency.  We have simply pointed out again and again that as long as the Chinese financial system remains essentially closed, it is impossible for the yuan to usurp the dollar.  Further, while the Chinese authorities have in the past hinted at their intentions to promote greater openness, real steps towards it would require them to relinquish key levers of control over the Chinese economy, and expose them to the same economic and monetary challenges that meet other developing and middle-income countries with open financial systems.

Whatever the rhetoric, we see that the Chinese government’s current direction is emphatically not in this kind of liberalizing direction.  The Chinese authorities believe that secure Party rule is the guarantor of continued Chinese prosperity; whatever reforms they propose will operate within the framework of the Party’s continued robust authority.  Over the long term, that may change; but the yuan is not likely to become systemically significant in global monetary flows for a decade at least, and perhaps much longer.

          China’s Rise: What It Will Actually Look Like

In his three-hour address that opened the 19th Party Congress, President Xi laid out the plan for China “to become a leading global power by 2050.”  The congress amended the Party’s constitution to enshrine some of President Xi’s contributions as “Xi Jinping thought” — effectively placing him on the level of Mao, the only other Chinese leader similarly honored.  Xi has led a robust anticorruption campaign, but as we have long observed, that campaign has not been a move in the direction of western liberalism.  It has been prompted by a recognition that corruption is so negatively viewed by the public that it is a threat to the stability of Party rule.  So far from sidelining himself, then, Xi has centralized power and gradually made himself the strongest Chinese leader since Mao.

This, then, is one key element of the roadmap towards China’s arrival as a “leading global power”: the unapologetic presentation of a political economic model fundamentally different from that offered by the United States and other liberal democracies.  At one point in its history, China struck out on its own in developing “socialism with Chinese characteristics,” charting a course independent of the Soviet Union and of its orthodox Marxism-Leninism.  Xi is casting the current moment as a renewal — a further stage in this development.  In the wider global context of liberal democracies’ struggle with upstart populist dissension, especially in the U.S. and Europe, China is sending a message to the rest of the developing world: “Our model works; it’s more stable than what the West is selling you.  You can grow and still maintain your power if you do it our way.”

This is a message that gets a hearing in the developing world.  The Chinese model is political authoritarianism, the robust presence of big state-owned enterprises, and a vibrant capitalism boiling underneath — protected, guided, and kept from excess by the state.  It will have a natural appeal to developing-world governments who want to grow their economies without giving up their own power.

Will it work long-term?  Probably not.  We think the historical record is clear, that individual liberty, property rights, and the rule of law build the most wealthy societies in the long run.  But this is not to say that the new Chinese model cannot be influential for some time.  It has been successful in China, at least in terms of economic growth and the alleviation of dire poverty.  However, of those developing-world governments inclined to follow this model, we suspect that few if any have the necessary culture for it to work as it has in China over the past three decades.  The Chinese are a strongly entrepreneurial people; culture and history very specific to the Chinese experience are also key ingredients of this development model, and they will be hard to translate into the economies of almost all other developing countries.

The second notable element of the new plan for “global power by 2050” is the “Belt and Road Initiative” (also called “One Belt, One Road,” or OBOR), which is now enshrined in the party constitution.  This refers to plans for extensive development of rail links between China’s west and trading partners in Eurasia, and maritime trade routes in China’s immediate environs in south and southeast Asia.  Thus far, OBOR has been painted in broad strokes.  It has generated some excitement, and even an ETF dedicated to the theme.

Like many analysts, we see a little too much excitement about OBOR; it’s a long way from investment primetime as a theme.  However, it is very significant as an indicator of China’s regional ambitions.  President Xi said in his address to the party congress that China has no desire to be a globalhegemon…  But the fact that OBOR has been written into the party’s constitution shows clearly that it is intent on being a regional hegemon.  That indicates the potential for ongoing tensions with its immediate neighbors, particularly Japan — which under Prime Minister Shinzo Abe’s new mandate, may itself be preparing for a more robust assertion of regional power.

Those were the more “hawkish” implications of Xi’s speech — reinforcing the Party’s intention to control both Chinese society, the “commanding heights” of the Chinese domestic economy, and China’s regional hegemony.  But beneath these, there is a more “dovish” reality, and that is part of what is driving the Chinese internet stocks higher.

          The New Model

China’s new model includes tight central political control with rapid technological innovation as a source of growth and as a means to continue extending the benefits of middle-class life to more and more Chinese citizens.  So far, it’s working.  We wrote earlier this year about how China’s rapid growth has produced severe social disruptions to which social media and e-commerce firms are responding, and in the process, developing products and business models that are actually ahead of their developed world peers.

Now, Chinese innovators are beginning to jettison the old “China copy-cat” model in high-tech fields from artificial intelligence to drones to autonomous vehicles.  While keeping a tightening lid on dissent, the government is embracing this Wild West of technological innovation, clearly proud of it and believing that it perfectly illustrates China’s success in rising to global prominence without embracing western liberalism.

The bottom line is that the Chinese economy is reaching an inflection point in sophistication — a transition that is being supported by the government.  It is an extension of the tacit social contract the government has maintained for decades: “Don’t demand too much political liberty, and we’ll deliver economic growth and rising living standards.”

Tech innovation is seen as a critical element of making that contract work.  In the U.S. and Europe, tech giants are beginning to come under regulatory scrutiny, with potentially negative long-term consequences.  For Chinese tech, this kind of environment is “native.”  China’s tech giants grew up under such conditions, and know how to navigate them and stay inside the lines.  Even in an environment of unapologetic political illiberalism, China’s tech giants may continue to be able to thrive as the vanguard of growth for the next phase of “socialism with Chinese characteristics.”

Investment implications:  China’s tech giants have performed very strongly in 2017.  As long as the macroeconomic environment remains supportive, we believe that many of them can continue to do well.  We particularly like internet-focused firms in videogames, e-commerce, social media, and video livestreaming.  While the direction of China’s leadership is towards tighter media control, many of these firms are comfortable operating in such an environment, and their experience and contacts allow them to be extremely adaptable to shifting political conditions and demands.  Overarchingly, the Chinese government will be eager to enable further tech expansion, both as a support to domestic growth and as an assertion of a rising Chinese presence in key global industries.  Please note that principals of Guild Investment Management, Inc. (“Guild”) and/or Guild’s clients may at any time own any of the stocks mentioned in this article, and may sell them at any time.  Currently, Guild’s principals and clients own BABA and Tencent.  In addition, for investment advisory clients of Guild, please check with Guild prior to taking positions in any of the companies mentioned in this article, since Guild may not believe that particular stock is right for the client, either because Guild has already taken a position in that stock for the client or for other reasons.