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3 Risks American Investors Are Facing in China Right Now

With lifetime tenure and the absolute power of China’s Communist Party, all trade and investments in China are subject to President Xi Jinping’s whims.

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According to Joshua Ball in a recent article for Global Security Review, China has, “provided security and economic prosperity for a growing middle class in return for absolute loyalty.” He then adds, “How long can the social contract endure?”

The concept that the Chinese citizen voluntarily gives up personal, religious and political freedoms in return for material advancement has been one of the primary intellectual mainstays of Western business leaders for almost two decades now. This core belief, repeated in a hundred articles, has given cover to both politicians and global corporations to make deals with China. After all, the government had the implied consent of the masses. Otherwise, those in the West who benefited economically from the rise of China would have to admit they were dealing with a nasty authoritarian government. More polished perhaps, for sure, but no different than say Venezuela’s Nicolás Maduro or Hungary’s Viktor Orbán.

Few in the West would want to admit that while looking in the mirror.

Unfortunately, there is not one shred of historical or contemporary evidence that any such deal between the Chinese people and the Communist Party of China (CPC) has been made. It’s just a convenient fable.

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Never in the 5,000-year history of China has a leader been voted in. There has never been an emperor who ruled with the consent of the governed. The closest the Chinese have ever come to being able to change their government is when an emperor lost “the mandate of heaven.” This signaled that warlords could muster an army and violently overthrow the errant emperor. That, in a nutshell, is the history of China. The transition from the wartime nationalist government (now in Taiwan) to the communist one was brutally violent. No one voted in Mao or the CPC. No citizen voted Xi Jinping into office.

What does this thumbnail history of China have to do with today’s investor? Everything. The West, with America in the forefront, has gone all in on China. The China trade now totals $660 billion. American investment in Chinese factories and other fixed property in 2018 alone totaled $118 billion. You can buy a Starbucks coffee, drive to Disneyland in your Buick while wearing a Ralph Lauren western themed outfit. Conversely, you can shop at Walmart or on Amazon and load up your cart…and everything is made in China.

It is not only household products, clothing and toys. Industrial machinery, pharmaceuticals and telecommunication technology are made there too. The ongoing war over Huawei’s ability to supply the U.S. with 5G infrastructure may be the Fort Sumter of a coming technology war.

As of now, several index funds (both equity and bond) are including Chinese companies in their listings. So even a passive 401(k) will be placing your assets in China.

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With lifetime tenure and the absolute power of the CPC, all trade and investments in China are subject to Xi’s whims. Day by day he and the party’s apparatchiks consolidate power and change whatever rule of law there was—to the rule of Xi.

What are the ramifications for American investors in China or for companies with significant exposure to China? I see three obvious risks.

Risk one: Having the CPC become your partner, via “worker cadres” required to be on your board, acting as worker representatives or dictating investment decisions. This is already happening as Xi has made it clear the party’s needs are a priority over private enterprise. In effect, Xi has set in motion the nationalization of every China-based enterprise.

Risk two: The party acting on the first risk will intentionally drain away profitability in order to favor the “home teams.” Take Starbucks, for example. A homegrown rival, Luckin Coffee mimics the Starbucks experience. Luckin is all Chinese and is listed on the NASDAQ. There could be a thousand hindrances thrown in Starbucks way, like phony health inspections by the CPC, to cripple it, thus boosting Luckin—even if Luckin turns out to have engaged in accounting fraud. That could be true for hundreds of foreign brands as Xi’s nationalism grows…along with President Donald Trump’s anti-Chinese sentiment.

Risk three: This is the most obvious of all and the easiest to implement—currency controls. China did this a few years ago to limit rapidly deprecating currency reserve outflows. The CPC simply put a mechanism in place to stop banks from transferring more than a set amount of cash abroad. This brought the buying up of Manhattan luxury co-ops and trophy vineyards in Bordeaux to a halt. If the CPC decides to impose cash reparation controls on foreign companies, then everyone from GM to Disney will have been nationalized via the back door of currency controls.

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Personally, I don’t think this is alarmist. Looking at what Xi has done to China in the past seven years shows, to even the casual observer, that he is a militant nationalist who is ruthless in dealing with those in his way. Just ask the Muslims in Xinjiang or this Swedish bookseller. Soothing words of cooperation and openness have yet to issue from his mouth. His subordination of the brilliant business elite has also been telling. Last week, billionaire entrepreneur and CPC member Ren Zhiqiang, a fierce critic of Xi and his handling of coronavirussimply disappeared.

Of course, there could be pushback. There could even be a coup. One-man rule can, and sometimes does, end in an unexpected denouement. The other possibility is that Xi and Trump will come to their senses and realize both economies are all in; they will rise or fall together.

However, investors must face one fact. The Chinese people at both the top and the bottom have given no consent to Xi or the CPC. They do what they have always done for thousands of years…acquiesce until they don’t.

Until all of this is made clear, it seems wise to limit investment in China and to mark all assets in China with a discount or as impaired. As Confucius says, “to see the right and not do it is cowardness.”

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