Letter From Shanghai: Optimism In The East

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China can manufacture – but innovation is a different matter

I have spent the last few days in China.  The stock market has collapsed over the past year by 70 per cent as GDP growth has slowed from 10 per cent to 7 per cent.  But the optimism amongst Chinese business people has not diminished and they remain confident that they can continue to generate wealth at a spectacular rate in the coming years.

This optimism looks rather misplaced in the near term as the US and UK stand back from quantitative easing (QE).  QE was undoubtedly the right policy in the aftermath of the banking crisis and allowed both economies breathing space for a number of years whilst the banking system repaired itself.  Both economies have returned to growth and unemployment has fallen sharply, but a key point for those trying to predict what the future holds for China is that wage increases have been pitifully low in the west and don’t look as though they are going to recover anytime soon.  So, this suggests that demand for Chinese goods will remain sluggish and this will be exacerbated further by the problems that the Eurozone is experiencing.

Many of the Chinese business people that I met whilst I was there argued that the Chinese economy was developing internal momentum and was becoming less reliant on export markets, but the evidence is not really there to support this argument.  I am old enough to remember the frenetic rise of the Japanese market and the moment that its total value surpassed that of the US market.

I vividly recall the long discussions that ensued as our investment team grappled with the idea that Japan potentially had a more exciting future than the US, which was what the markets were telling us.  However, we disagreed, believing that the weakness of the Japanese was that they were not innovators.  They were exceptionally good at copying and miniaturizing, but they could not innovate in the way that the US could and so we sold all of our Japanese equities, which proved to be the right decision.

At this point, China is facing the same question that Japan faced at the end of the 1980s.  Can it innovate?  If it cannot, then it will find it difficult to keep up its economic momentum.  There is evidence that it can utilize existing technology to innovate and hence the incredible success of Alibaba, but where is the Chinese equivalent of Silicon Valley?

These macro-economic arguments have a corollary. If you want an asset class that’s not directly related to the gyrations of the stock markets – Chinese, US or UK versions – a loan to a quality, carefully vetted company on the Money&Co. platform is surely worth considering.


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