China starts consuming itself

The future in China looks far darker than we imagined with large implications

A friend of mine recently sent the following article from Politico: here

I did not originally realize that Li Keqiang’s untimely death was caused not just by a “heart attack” but by a “heart attack in swimming pool”. That almost certainly means he was murdered by the government.

This is in the context of a much larger purging of officials that the article goes in detail about. Xi’s paranoia is pretty legendary at this point, and the fact that China is collapsing economically and demographically is only fueling a more intense paranoid introversion on the part of Xi. Keep in mind, we are talking about a man (Xi) who didn’t know massive industrial electrical blackouts were occurring in China until the United States informed him of this. Don’t be mad at the US, we could see it was occurring from space. I think we just assumed he had to know (he didn’t and our intelligence later confirmed that).

What’s fascinating now is that he is purging his own loyalists and supporters. The state is in essence, consuming itself. This happened under Stalin as well. WW2 and later, Stalin’s death, short-circuited what would have followed: The demise of the USSR. Instead, due to Khrushchev's reforms and Brezhnev’s sclerotic “status quo” stability eras, the USSR was able to cling onto life support for a few more decades.

But the USSR was in far better shape then than China is currently. China’s population is in free-fall, they are struggling with deflation (that’s not a typo), foreign investors have pulled their capital out of the country completely, massive debt levels and misallocations of capital abound. Corruption remains endemic. Weighted average cost of capital is massively increasing as are labor costs and industrial inputs. Western business executives that visit China are often arrested arbitrarily or denied permission to leave for months. This is all while China’s technocratic system has been largely eliminated and replaced with a cult of personality around Xi Jinping.

As if this wasn’t enough, western banks pulled out of Russia before sanctions even hit, when Russia amped up its ongoing war in Ukraine. Chinese banks flooded into Russia to fill the void. As a result, western banks tried to conduct due dilligence to quantify their exposure to Russia vis-a-vis China, but those due dilligence firms were raided and forcibly shutdown by the Chinese government. As a result, western banks have also started pulling out of China rapidly due to a secondary sanctions risk. Consequently, China has rapidly become uninvestable for most investors and businesses.

Not very long ago, someone close to me let me know that Aalberts, made a decision to close all of its manufacturing that was in China (at least in one of its divisions) and move it all to the United States. In a deglobalizing world, we will see more of this or things like it (such as moves to Vietnam, India, Mexico, Europe, etc.)

Speaking of Chinese wages let’s take a look at this:

^ The Chinese are no longer truly cost competitive. The main reason we still think of them as being so is because of sunk costs for property, plant, and equipment, and because of massive (and unsustainable) Chinese government borrowing to prop up domestic industrial firms.

Firms are not going to pull out of China overnight, but the outflow has started, and is going to accelerate from here. Companies who started decoupling earlier (such as Walmart) will be in better shape than those who started later (like Apple) in terms of the health and costs of their supply chains. Tim Cook’s unwillingness to acknowledge reality has come back to hurt Apple, and now that he’s belatedly (and reluctantly) realized this, he has slowly started to try to pivot out. He’ll discover that many other firms are ahead of them in the queue for limited labor and industrial resources elsewhere, driving up costs for Apple to get a slice of the pie. This could have been avoided for Apple if Tim Cook had not been in charge.

Now… Apple is selling iPhones in China (one of its largest markets that it depends on for consumer purchases). However the long term trend there in that consumer market is one of shrinking, and not just for iPhones but across the board. Here is an example from vehicle sales and purchases:

^ The number of vehicle sales not only hasn’t recovered since the pandemic, but actually peaked about a year to a year and half before the pandemic began. Due to demographic and economic reasons, one can count that it is highly unlikely it ever will recover.

While we’re on the topic of manufacturing, let’s take a look at inputs, either industrial or value-added for China’s manufacturing system, and the level of risk associated with each one:

^ Pretty atrocious. Especially in a rapidly deglobalizing world. This is a recipe for internal instability in China (to vastly understate it).

One analyst has called China a “badly run Enron” but I think that’s being too optimistic. If you’re an investor, make sure to account sufficiently for these risks before taking an investment (especially in a non-equally-weighted international fund).