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The Next Conundrum?

Ichiro Suzuki

The economy appears to be dying a slow death. It must be too much to say this on the Chinese economy. This statement, instead, was applied to the Japanese economy until about a dozen years ago, and China today is suffering from the Japanese disease. After years of mismanaging the economy following the burst of a historic bubble, Japan went through a quarter century of slow adjustment process. It suffered sharply lower asset prices and stalled economic growth amid very low inflation that often registered negative numbers. A paradigm shift hit the Japanese economy, making it clear that the system that brought an economic miracle had run through its course though it took a while before it became a shared consensus. Politics became unstable as the economy floundered. The Liberal Democratic Party was thrown out of power in 1992 for the first time since its birth in 1955. During a dozen years of two U.S. presidencies under George H.W. Bush and Bill Clinton, fifteen men came and went as Japan’s prime ministers. Then at the beginning of the 21st century, immensely popular Junichiro Koizumi’s tenure largely overlapped George W. Bush’s presidency. Then again, four PMs led the government in five years, in part due to the deepest global economic downturn since the 1930s. During the Great Recession, the vast majority of incumbent parties in democracy lost elections, including the LDP, the Republicans in the U.S. and the Labour Party in the U.K.  Japan had to wait until the second stint of Shinzo Abe who refitted the economy to the post-growth era with declining population growth. 

As China is going through a paradigm shift that has made its growth model obsolete, politics remains uniquely stable. Of course, there is only one political party in the country, where the Chinese Communist Party monopolizes power. Inside the CCP, President Xi Jinping last year entered the third five-year term, for the longest tenure since the death of Mao Zedong in 1976. Men who might threaten him have been removed out of the upper echelon of the party. There is a reasonable chance that this five-year term is not Xi’s last. China’s problem is that the man with a dominant power has a poor grasp of the economy. Policies he brought into the economy over the years have been out of steps with prescriptions necessary to lift the ailing economy. Of all, ‘common prosperity’ stood out but this is only one of many. The Chinese economy needs radical restructuring but the stability-obsessed ruler has zero interest in embarking on it since it destabilizes the country. By now, it has become abundantly clear that political stability as defined by the CCP takes precedence over economic prosperity. It would be nice if whatever the CCP does delivers growth. But if it doesn’t, so be it. They would never say this but deep in their mind they might think that stagnation under the CCP is better than growth under a different regime. Even if Xi Jinping is ousted one day, the next man at the helm would not liberalize the economy. Further into the future, the CCP might be thrown out of power in a very disruptive and messy process. Change of power would bring nothing but a stable transition period. There is a high likelihood that China descends into a chaos. There is so much to speculate on this.

If and when the CCP begins to lose the ironclad grip on the economy after years of stagnation, there is one sector of the economy that might revolt against the authority more fiercely than others. It is the household sector. China’s household sector financial asset was estimated at $85.1 trillion in 2022, the second largest after the United States’ $145.8 trillion and was more than three times as large as No.3 Japan. This massive asset is essentially trapped in the mainland under tight capital control. Under dire states of both the real estate and stock markets, households are denied chances to become rich with few attractive places to invest. Some jumped onto financial products offered by banks and asset management companies, and got burned. Some are staying with government bonds or bank deposits. Meager returns they offer might be still better than losing money, as Japanese households have learned, but Chinese people are willing to embrace greater risks. Some astute investors are buying gold that offers Chinese people a rare non-restricted opportunity to participate in international markets. Gold’s rise in recent months is speculated as Chinese buying. Gold price is usually inversely correlated with the movement of the dollar. This time around, however, it is rising amid persistent strength of the greenback. Of course, some money always finds its way out of the mainland, escaping capital control, with its destinations in houses in the United States, Canada, Japan and elsewhere. Migration of Chinese money from Hong Kong and Shanghai is in part responsible for a recent bull market into Tokyo. 

Twenty years ago, then Fed Chairman Greenspan called it a ‘conundrum’ looking at falling long-term interest rates. Bond-buying persisted though the U.S. economy was evidently out of recession caused by the tech bubble’s burst at the outset of the 21st century. As it turned out, it was China’s sovereign wealth fund that was quietly buying Treasury notes and bonds at a time when conventional investors wouldn’t do. Back then, China began to accumulate external surpluses and foreign exchanges they earned had to be parked somewhere. There was and still is the only one asset that can absorb trillions of dollars without disruptions. It is the U.S. Treasury market. This was an act of institutional investors. Retail money on the other hand wouldn’t chase Treasury notes and bonds, seeking greater risks. Individual investors are strongly interested in houses, but this asset class is not for everyone, constrained by the required size of investment, usually a million dollars or greater. In addition, some local authorities are already vigilant on their housing market so that it is not disrupted by inflows of foreign money, like the city of Vancouver. This leaves equity as the most likely asset class as Chinese retail money’s destination. Such movements could result in equity version of conundrum, an upward shift in valuation, against a conventional wisdom. When the Federal Reserve Bank succeeds in downsizing its balance sheet later in this decade or in the 2030s through reversing of quantitative easing in the 2010s, a conundrum effect could be the next mover of stock markets in the U.S. and in the rest of the world. 

About the author: Mr. Suzuki is a retired banker based in Tokyo, Japan.


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