China's Ongoing Economic and Political Developments

Todd Millay, the managing director of Choate Investment Advisors, and Andy Rothman, an investment strategist at Matthews Asia, discuss the origins of the virus in China, its effect on the Chinese economy, and how China is recovering after apparently containing the outbreak.


Todd Millay:  Hi this is Todd Millay, I’m the managing director of Choate Investment Advisors and I’m here today with Andy Rothman of Matthews Asia.  Andy’s lived and worked in China for over twenty years.  He had a long career in the U.S. Foreign Service before he began to work in investments and that included being the head of macroeconomics and domestic policy in the U.S. Embassy in Beijing.  Andy joined Matthews Asia in 2014 and is an investment strategist there.  Andy thank you so much for talking to me today.

Andy Rothman:  Great to be here with you Todd thanks.

TM:  I wanted to start by asking you about the virus.  Obviously it’s something that’s affecting the entire world, but it started in China and hit during a particularly bad time for the spread in the middle of the Chinese New Year.  It seems that China is furthest along in terms of dealing with the virus and controlling it.  I guess the first question I had for you is, do you think the virus is actually under control in China?

AR:  Several great questions and it is good to start by talking about the virus because I think in China and everywhere else the next several quarters of economic activity is going to depend on how well we can control the virus.  In China, I think they have done a really good job.  People have been steadily, gradually going back to work and normal activities over about six weeks now and there hasn’t been a significant spike in new cases or fatalities due to Covid-19.  And that’s a really positive sign so I’m actually feeling better now than I was a month ago about the ability of the Chinese authorities to control this.  We’ll know a lot more soon because China is just finishing up a long weekend Labor Day holiday where there were a lot of people out on the road traveling a bit and getting out and socializing and so in two weeks if we don’t see a spike in cases then I can I think we can feel pretty comfortable about it.  And one other point I’d make is actually China was lucky that the virus broke out during the Lunar New Year holiday because that meant that migrant workers, who have suffered the most in terms of job loss, were home rather than in the urban areas where their jobs are.  If they had been in the urban areas, they would have lost their jobs, maybe been kicked out of their dormitory housing, and it would have been quite tough for them.  Whereat least most of them were in their home towns where they had a place to live and some family support.

TM:  You mentioned in a couple of weeks we’ll know whether there has been a recurrence and one question has been the reliability of data coming out of China.  Can we trust the data in China on the virus?

AR:  Yes another great question.  Let’s go back to the beginning.  It is pretty clear that in late December and early January, local officials in the City of Wuhan and Hubei Province where Wuhan is the capital did obstruct efforts by the central government to send teams from their CDC and their health ministers.  There is no question about that and that delayed efforts to really get a handle on the disease and start working on it.  But my view is that since late January, on the 20th of January, their Anthony Fauci, Dr. Zhong Nanshan went on television and discussed the fact that they had come to the conclusion that there was human-to-human transmission of the coronavirus and on January 23rd, the Chinese government locked down the city of Wuhan which is a city as big in population as New York City.  So that was a really big turning point and I don’t think we have evidence that the Chinese government since that time in late January has deliberately covered up information about the virus.

TM:  That was quite a Draconian lockdown in Wuhan.  Another question is how much can a more open western society learn from the Chinese experience in controlling the virus.  How relevant is their experience to what we are doing in the U.S. or Europe?

AR:  I think we could learn a lot.  Wuhan was extreme, but there were only a few other cities in Hubei that did something as Draconian as what was done in Wuhan.  Most of the lockdown in China was closer to what we’ve seen in South Korea, in Australia and New Zealand and to a certain extent in the San Francisco Bay Area in Northern California where I live right now.  And it’s been pretty successful.  So one of the reasons that I have a reasonable amount of confidence is that the Chinese data is not being deliberately distorted is that the epidemiological curves that we’re seeing in China are pretty similar to what we’ve seen in several other countries where we have greater faith in voracity of the data such as South Korea and Germany and Singapore and New Zealand.  I think we can learn a lot, what we can take away is that testing and contact tracing and isolation where necessary works and it’s really brought down the number of cases and the number of fatalities dramatically in China. 

TM:  You mention that China’s now trying to get back to normal and I’d love if you could just paint a picture of what that looks like.  I understand that Chinese theatres are still closed and people aren’t traveling as much, but what has been the kind of the reopening process in China?

AR:  In general I think that things have been picking up nicely.  They started reopening outside of Hubei Province in early April and by the end of April the 76-day lockdown in Wuhan was over and they started opening up there and consumer spending, which is the biggest part of the Chinese economy is bouncing back.  So, we’ve seen for example, that auto sales and properties sales are within 10 to 20% of where they would normally be this time of year based on past averages.  That’s after going down to really no activity at all in February and March.  So, I think things are coming back.  Mercedes said that in March they sold as many cars as they sold in March the previous year.  Tesla had its best month in China ever.  So, on big-ticket items that require not only a lot of money but I think consumers being pretty confident of the future, things are coming back.  You mentioned movie theatres, things like that, airplane travel, even restaurants, anything that’s going require people to gather in a confined space, it’s going to take a lot longer to come back.  So, I don’t think the Chinese economy is going to go back to normal this year, but I think the recovery in the consumer and manufacturing part of the economy is picking up steam quite well.  So, the Chinese were first into the virus, first out and I think their recovery assuming, that the virus doesn’t come roaring back again, is going to be ahead of our recovery as well. 

TM:  You mentioned that some non-Chinese companies, like Mercedes and Tesla, that do a lot of business in China.  Could you talk a little bit more about companies that may be more familiar to U.S. investors that have important markets in China and how they are faring?

AR:  Sure.  So first I think it’s really important for investors to understand the pretty dramatic structural transformation that the Chinese economy has gone through just over the last decade or so.  For example, before the global financial crisis in 2007, the gross value of China’s exports was equal to about 35% of their GDP.  Last year it was only 17%.  Over the last five years on average each year, next exports, that’s the value of the country’s exports minus their imports.  Net exports contributed on average to zero to China’s GDP growth.  So this is no longer an export-led economy and manufacturing is now taking a back seat to domestic demand, a consumer story, just like in the United States.  So last year was the eighth consecutive year in which the tertiary part of GDP, the consumer and services part was the biggest part.  It was bigger than manufacturing, construction and last year almost sixty percent of Chinese GDP growth came from consumption.  So a lot of foreign companies, including a lot of American companies have taken advantage of both this structural change and China’s pretty good, but not complete compliance, with their WGO commitments.  So, for example since China joined the WGO, U.S. exports to China are up over 500%.  They’re up about 100% to the rest of the world.  GM now sells more cars in China than it does in the United States.  Nike, up until the coronavirus hitting, had 22 consecutive quarters of double-digit revenue growth in China higher than in North America.  Companies like Apple, Tesla, Nivea, Qualcomm, and Intel all get more than 20% of their global revenue from China.  So, even if you never invest directly in a Chinese company, understanding what’s happening in the Chinese economy is really important to most American investors, because you’ll probably own a company that is getting a significant share of its global growth from China.

TM:  Well that’s something I wanted to ask you is how necessary is it for investors to invest directly in Chinese companies versus just investing in U.S. companies that benefit from China having that be their exposure to China.  What benefit can you get from investing directly in a Chinese company?

AR:  Here’s how I look at that, so over the last decade, that we’ve just been talking about with structural change, over the last decade, on average every year, China has accounted for about one-third of global economic growth.  That’s a larger share of global growth than from the U.S., Europe, and Japan combined and that’s being driven by the Chinese consumer.  So as an investor, I think it’s important to have some exposure to this driver of global growth and if we do that via multi-nationals we only get a pretty narrow slice of that, because while GM sells more cars in China than it does in the U.S., China’s only about 20% GM’s global revenue.  So 20% is big, but it’s not the whole story, so are you getting enough of a China play by owning GM or Apple or Tesla as opposed to owning a Chinese company whose sole business is selling goods and services to Chinese consumers and these are Chinese consumers who have seen their income rise at a phenomenal pace.  So over the last decade, average inflation-adjusted real per capita income in China has gone up about 8% a year versus less than 2% a year in the United States.  So I think having someone help you do due diligence on individual Chinese companies selling goods and services to Chinese people is a better way to get that exposure and then the other point I’d add is that in the period of time and I know we’ll talk more about this later, in this period of time of rising tension between the governments in Washington and Beijing, it’s probably better to be focused on Chinese companies selling in China rather than American companies that could get caught up in those political tensions. 

TM:  I wanted to ask you about that and it does seem that China and the U.S. are moving into more of an antagonistic relationship as opposed to a symbiotic one that they have had previously.  What effect do you think that that’s going to have on China and the Chinese economy and I guess also on the American businesses that count China as an important market?

AR:  So, let me answer that from two prospectives, let me go back to my perspective as an America diplomat as a foreign-service officer for 17 years, from that perspective I am really distressed by what’s happening to U.S./China relations.  These are arguably two of the most important countries in the world from an economic and a security perspective.  It’s really important that they collaborate where they can and that where there are differences they get sorted out in a way that is not confrontational and that is constructive.  I think that is what largely happened over the past four years, but we’re drifting away from that, so I’m really worried because where issues that many of us are concerned about whether it’s climate change or being on guard for the next pandemic or fighting terrorism and money laundering and drug dealing, I mean we’re just not in the United States going to be able to make efficient progress on these issues without China working with us.  From an investor in economics perspective, it is a little less troubling right now, because as I mentioned, China is a domestic demand-driven story like the United States.  So, even a disruption in trade will have a modest impact.  I mentioned that the gross value of China’s exports last year was equal to 17% of GDP net export generally contribute nothing to China’s GDP growth.  So the impact will not be zero, but somewhere between zero and 17%.  But also keep in mind that last year the U.S. only took 17% of China’s total exports.  So the impact of a U.S.-centric problem is relatively small.  And then from an investor’s perspective, this is why we are really focused in our China strategies and our regional strategies that have a heavy China waiting on Chinese companies selling goods and services to Chinese consumers because that has been and should continue to be pretty well insulated from these bilateral disputes. 

TM:  And how insulated in China from the spread of the virus in its area?  China has apparently gotten the virus under control, but in the rest of developing Asia, it seems like it is still quite a problem.  Will that have a negative impact on China?

AR:  Yeah, that is a point that is relevant to us too when we look at individual states or even cities or counties making their own decisions about when and how to relax restrictions.  Just today I read that a public health official in Washington State said that individual states and counties making different decisions on relaxing controls is like saying that it is okay for kids to pee in part of the swimming pool but not on the other part.  And certainly, the same thing applies to China.  So they have been significantly restricting access from abroad into China.  There are limited number of flights, you can arrive only in certain airports, everybody is tested and quarantined when they arrive and they have been finding cases that way, but they have been isolating them.  They have just now announced an agreement with South Korea and they are working on one with Hong Kong to allow people to go back and forth between those places because the number of cases has come down so low and there is adequate testing and contact tracing there.  It wouldn’t surprise me if they start doing the same thing in New Zealand soon.  They seemed to have solved the problem there.  But, yeah they’re going to be on high alert and I worry that it’s going to be a long time before I’m going to be able to go back to China.

TM:  This has obviously damaged China’s relationships with a number of countries.  In this country, there are those who are asserting that the virus actually originated in a laboratory in Wuhan.  Could you talk a little about those rumors and how China is responding?

AR:  Sure, so there are several different stories out there, let’s look a few of those.  One is that the thesis that the coronavirus which creates the COVID-19 disease was created by man and in a lab in China either as a weapon or for some other reason.  Scientists in the United States and in the UK have studied this in several different settings and have all concluded that there is no evidence whatsoever of any man-made manipulation of this virus.  So, I think that the scientific community including Fauci, has agreed that there is no sign of this.  Another more nuanced question is okay, if the virus was, I should also add that the director of national intelligence, an appointee of President Trump, put out a public statement last week, saying that the intelligence community’s assessment is that based on that science that this was not a man-made virus.  My more nuanced thesis is that the virus wasn’t man-made but it was being studied in a viral lab in Wuhan and somehow escaped accidentally and started infecting people.  There is right now no evidence of that.  It’s also really hard to prove a negative.  How do you prove it didn’t escape from a lab.  But the same public statement from the office of the Director of National Intelligence in the U.S. government that I mentioned said that they are looking into that theory.  That was on Thursday, so my interpretation of that statement based on my experience in the U.S. government and working with the intelligence agency is that as of last Thursday, they did not have any compelling evidence that there had been an accident.  My personal view is had there been an accident at the lab in Wuhan, and it was an accident that people understood to be an accident, scientists would have been on the phone and they would have been on we-chat, their version of Twitter and our intelligence agencies would have picked up that chatter and we’re not seeing any evidence of that.  So I think that over time we’ll probably come to the conclusion that this virus jumped from a horseshoe bat to a human somewhere in rural Wuhan where those bats tend to live and that over time the virus made its way into Wuhan.  People got sick in rural China, but nobody understood that this was a new virus they just saw cases of pneumonia and things like that and it was only when people started getting sick in more advanced hospital settings in Wuhan that people started put that together.  So my guess is that it didn’t start in that famous or infamous wet market there, but that was just one of the hot spots. 

TM:  You talked a bit at the beginning about how much China’s economy has changed, I was hoping you could elaborate on that.  I think that many people in the U.S. might have an outdated view of China and its role in the global economy.  Could you expand a little bit on your comments and particularly how you see China’s economy evolving over the next few years?

AR:  Sure, I’d like to draw on my personal experiences to answer that question because I’ve been really fortunate to have been an observer and an analyst of China over a period of amazing change.  I first went to China as a student in 1980.  In 1979 the U.S. and China re-established diplomatic relations, so when I was in college in New York, one of my economic professors just happened to be Chinese and he got a grant from a foundation to take a small group of students there for a month to travel around and I had the opportunity to do that.  I really wasn’t interested in China at that time.  In fact, I had told my mother that I had gotten this invitation to go on this trip.  Her response was “You don’t even like Chinese food, why are you going to do this?” and it’s true, the Chinese food that I grew up on was pretty awful.  But that got me really interested and when I joined the state department a few years later, I asked them to teach me Chinese and send me back there and the place was a mess.  So I would say the first 15 years that I was there studying in China I was really pessimistic about the place.  They couldn’t feed themselves, the quality of life was awful, the depressive nature of the Communist Party was just terrible.  The Communist Party back then controlled every aspect of every Chinese person’s life.  They told where to go to school, what to study, and what school, they assigned to you to a job.  You couldn’t move to another town unless they approved it.  It was even hard to get a train ticket unless the Party gave you permission.  They could even veto your choice of spouse back then.  Today, all those things are gone and people’s personal freedom has improved just to an extent that’s hard for us to understand here.  It’s gone from being totally, maybe the virus is a good example, you’ve gone from being totally locked down to being unlocked and free to do anything you want other than to challenge the Party on political issues.  So while there is no political freedom in China, the degree of personal freedom and economic freedom is dramatically and better than it was before and that’s one of the reasons why I’ve become much more optimistic about China having seen how bad it was and how much it’s improved over the last couple of decades and it’s also why I feel like U.S. engagement in China on the economic, political, social and cultural and scientific level has really worked.  It’s helped us, it’s made us richer and it’s also made Chinese people much richer, both in terms of material life and also their personal life as well.  So you’ve gone from a place wherein the early 80s when I was in China, if someone’s relatives from Hong Kong were coming to visit, the people in Guangzhou, where I was working in the American consul at the time, would write and ask them hey can you bring me a radio or an electric fan because I can’t get those or I can’t afford them.  This is now the country just 40 years later where their responsibility for a third of global luxury sales and where GM is selling more cars than they are in the U.S.

TM:  Andy thank you so much for your time.  It’s been a very interesting conversation and I really appreciate your perspective.  

AR:  Thanks Todd it’s great to be able to have the opportunity to talk with you.


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