Challenging the 5 Biggest Misconceptions About China’s Economy

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A company with monopoly rights on trade with France’s colonies in Louisiana was established. It was generating a flow of dividends, distributed among the holders of the company’s shares. Initially, the government converted a small amount of the government debt into the shares of the new company. The company became known as the Mississippi System.

Then a truly revolutionary development emerged – the company was granted a right to launch a bank that could print money. The company has used the new money to buy its own stock. Very quickly the price of the Mississippi stock skyrocketed, and more and more trend-following government debt holders were eager to convert the debt into the Mississippi stock. Simultaneously, as the stock price went up, the dividend yield, or interest rate, went down, close to zero levels.

The rest of the story is in the history books. A more detailed description of the Mississippi System’s mechanism can be found in a remarkable biography of Richard Cantillon1, one of the designers of the system.

Strikingly similar to the case of the Mississippi System, starting from 2008, multiple attempts were made to use the printing press in order to decrease the interest rates by buying the government debt, which led to a substantial appreciation of the latter. This time the system was named Quantitative Easing.

Until recently, China has been the largest participant of the system, holding more than $1.5 trillion of US government debt. Beijing had received most of it in exchange for the exported goods that drove the US consumer boom of the 2000s. On a side note, as the largest holder of the treasuries, China has become the main beneficiary of the Quantitative Easing mechanism, gaining approximately $150 – 200 billion, excluding interest. Despite that this deal is history’s third most profitable transaction, after Alaska and

Louisiana acquisitions, it doesn’t receive much press coverage.

It is possible that the China’s think-tanks have studied the economic history of the 18th century, which means that the decreasing reserves may be an indication of China unlocking its capital from the treasuries and employing it in natural resources, real

estate and other real assets around the globe. What seems like a capital outflow may in fact be a capital relocation away from the second Mississippi System.

1 Antoine E. Murphy, “Richard Cantillon – entrepreneur and economist”, Oxford, 1986.

LONG JING CAPITAL VLADIMIR@LONGJINGCAPITAL.COM

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Quantitative Easing - one of the most profitable transactions in history.

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Capital outflow and decreasing reserves may be an indication of reserves relocation.

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3) China’seconomyhasstoppedgrowing.

The slowing growth of China’s economy is a fact. But what is misunderstood is that it is not an abnormal situation – it is just the law of physics. Indeed, if China’s economy continued growing 10%+, in less than 30 years it would account

for up to 75% of the world’s economy.

When a pine tree grows 3 feet per year, in the third year it grows 50%, but in year 20 – only a modest 5%. Can we say that a 20 year-old pine-tree is in crisis?

One of the reasons of this misunderstanding appears to be the media’s natural tendency in pursuit of advertisement budgets to hype the news by playing with the wording. Indeed, who would bother to open an article titled “Growth down from 7.4% to 6.9%”? Instead, “China Economic Growth Is Slowest in Decades” will get much more clicks.

4) Stockcrashisanindicationoftheweakereconomy.

In the US, where well-developed equity markets have become one of the major sources of capital for businesses, stock markets are a relatively good indicator of the performance of the entire economy.

China’s equity markets, despite their enormous size, are still in their infancy stage. Most of the economy is still financed by bank capital, not equity capital. Hence stock exchanges are still largely detached from the real economy – they are very much like a casino

(some may argue though, that even in the developed western markets stock exchanges’ role is not much different).

Until China’s stock market reaches a more advanced development stage, using it as a yardstick to measure economic activity will lead to false conclusions.

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Slowing growth is a natural process, and not an indication of a crisis.

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China’s stock market is still detached from the real economy.

LONG JING CAPITAL VLADIMIR@LONGJINGCAPITAL.COM

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II. STRATEGIC MISUNDERSTANDING - HISTORY’S LARGEST ELEPHANT IN THE ROOM

5) Transitiontohighvalue-addedmanufacturing.

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