One hundred years of Chinese communism
The French Concession is a well-preserved piece of France in Shanghai. Wide boulevards, green plane trees and old French mansions remind us of the Paris of a century ago. In that old French Concession lies the building of the First National Congress of the Chinese Communist Party. That congress was held in the summer of 1921. On 1 July 2021, the same Chinese Communist Party will celebrate its centenary and is by far the most powerful political party in the world.
Inflation is central to Chinese ideology
A hundred years ago, China was a poor and divided country. There was a great famine in the North and the country was divided between warlords and foreign powers. The vast majority of its 400 million inhabitants lived in the countryside. From day one, the new Communist Party set great store by national unity and integrity. Important in a vast country with great internal diversity. A country that is not easy to govern. The mountains are high, the emperor is far away. In fact, the Chinese Communist Party is nothing more than yet another imperial dynasty. The Chinese have a different view of democracy than the Westerners. Social harmony is more important than the rights of the individual. Democracy only leads to division. The social contract is that Beijing is the boss, but that its inhabitants can get rich by working hard. To a large extent, this has been achieved. No more famines, and more and more prosperous Chinese. The Communist Party is very keen to stay in power. The collective trauma of the now 90 million party members is the protest on the Square of Heavenly Peace in 1989. The party took firm action against the students. To be able to study at a university in Beijing in 1989, one’s parents had to be members of the Communist Party. So it was the children of the elite who died. Compare it to Boris Johnson shooting at Oxford and Cambridge students, or the US government having to use force to quell a rebellion at Harvard. The protests were partly caused by the high inflation rate of 20 per cent in 1989. That collective trauma has ensured that the Chinese central bank, like the Bundesbank (monetary policy there was long based on the inflation trauma of 1921-1923), is much sharper on inflation than, for example, the Federal Reserve and the ECB. The Party members were also brought up Marxist and taught that society is shaped by economic factors, of which inflation is one of the most important.
Relationship between the United States and China
After the founding of the People’s Republic of China in 1949, American policy was aimed at containing the communist danger. The Americans believed that if one country fell into communist hands, other countries would fall like dominoes. In 1972, an American president visited the country for the first time, and in 1978, Deng Xiaoping introduced ‘capitalism with socialist tendencies’. Like any good Chinese emperor, Deng was a pragmatist – it was all about the result. Thanks to a series of reforms, China is now the world’s second-largest economy and will overtake the United States in the coming years. The two economies are closely intertwined. Many American companies have outsourced production and moved to China. The dollars that China has earned from this are in, among other things, American government bonds. The country now owns more than USD 1 trillion of the total USD 28 trillion in American debt; only the Japanese have a little more. During the Great Financial Crisis, China experienced the downside of this relationship. Since then, China has wanted to be less dependent on the United States, on the dollar, and on American banks. China wants to become more self-sufficient and is trying to position the renminbi as an alternative to the US dollar. The focus is less on exports and more on domestic consumption. This is made possible by demographic developments. In the past, high economic growth was required because many millions of people were added to the labour force every year, caused by migration from the countryside to the city. Now, because of the one-child policy, 300 million fewer Chinese have been born since 1979. This is causing a shrinking labour force and, in time, a shrinking of the total Chinese population. As a result, the social contract is also changing. Beijing no longer has to ensure that everyone gets a job, but now aims to maintain prosperity in the broadest sense. Since the number of elderly people is growing rapidly due to the ageing of the population, the importance of maintaining purchasing power (read: a moderate development of inflation) is increasing. A strong currency helps in this respect, and if the renminbi is given the status of a reserve currency, it will gain strength. Thanks to Alipay and WeChat, virtually all payments in China are digital, and digitising the renminbi will give it a greater international role. Stability is important for reserve currency status. Just as the Chinese hold more than 1 trillion in US government bonds, foreign countries should also be able to park the surplus renminbi on the Chinese capital markets.
Investing in China
Due to its size and growth, China is becoming increasingly important to investors. As the country strives for self-sufficiency, it is no longer obvious that investors benefit from strong Chinese growth via foreign multinationals. The growing influence in the region has created a large economic power block, one that is already less dependent on the US dollar. For investors, this means more diversification opportunities by investing directly in the region. Whereas in the past the investment performance of Asia was mainly a derivative of the development of the US dollar, Asian equities are now gaining their own momentum. The Chinese influence in the region is also improving economic stability, allowing interest rates and risk premiums to fall and valuations to rise in Asia. The Chinese central bank’s focus on inflation makes it, like the Bundesbank before it, much more of a friend to savers and bond investors than central banks like the ECB and the Federal Reserve. That is where monetary madness has struck. The ten-year interest rate on Chinese government bonds is still above 3 per cent, clearly higher than Chinese inflation, while the conservative policy of the central bank argues that Chinese interest rates should be below European and American rates. That will not happen overnight. At the end of the 1960s, German interest rates were 2% above American interest rates, but fifteen years later and with a good dose of inflation, German interest rates were 2% below American interest rates. Moreover, in the 1960s there were still four D-marks in a dollar, whereas in the early 1980s there were less than two. If China experiences a similar development over the next ten to fifteen years, then Chinese government bonds in renminbi could provide a return that would not be out of place on the stock market. The status of reserve currency also includes the role of safe haven. And it is precisely these safe havens that have become very expensive outside China.