What Are We Missing in China?

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1:24And now to the top analysis of today's markets.

1:34What do we need to know about China? Welcome to the Real Vision Daily Briefing. It's Monday, April 10, 2023. I'm Ash Bennington. I'm joined today by Li Chen Ren, director of Modern Alpha at WisdomTree. Welcome, Li Chen. Thank you, Ash. Well, I teased it a bit at the top of the show. You focus on emerging markets, especially China and India. Where are we right now? I think China and India are still going to be the farthest growing emerging markets in the next couple of years. And it's going to put it in the geopolitical terms. India is actually interesting because India now can take a cover for U.S.-China competition.

2:18So it actually can benefit significantly from both the growth story and the geopolitical story. For WisdomTree, we take a little bit of an ex-state-owned view. So when we invest in China or India or in emerging markets overall, we have strategies that invest in private companies only. And I think that's where emerging markets, really the vitality of the economic growth comes from. Yeah, by the way, I should say for folks who aren't familiar, tell us about WisdomTree. What do you guys do? Yeah, so Wisden Tree is a pure ETF shop. We have significant ETF strategies across not just equity, but fixed income.

3:06We have one of the largest floating rate fixed income strategy, which in the current Fed interest environment has gained a significant exposure. And we also have alternative strategies like PutRide. So we use a transparent and systematic strategy. So all of our strategies are open, whether it's index or active strategy, transparent and open and also for ETF, daily holdings, it's all transparent to investors. So that's what we are good at. We are also starting a wallet, digital strategies for retail investors who are much more interested in the whole solution instead of just single ETFs. We also have a quite growing model business.

4:07So Western Tree is, I know most people know about Western Tree as dividend-weighting or hedged Japan or hedged Europe, but we've branched out into several areas. So let's talk a little bit about some of the news flow that we've got today. We mentioned China at the top of the show. This is an interesting quote. This comes from Jay Shamba. This is the Treasury Undersecretary for International Affairs. recently, actually, earlier this afternoon, late morning, I believe with David Weston on Bloomberg, quote, we occasionally have issues with different economic policies in China, and we will always defend US economic interests as well, always a pretty standard statement there.

4:48But we will not, will not in any way be trying to separate these two economies entirely. This is neither practical nor in our interest. A surprisingly strong statement from the secretary or the undersecretary, I should say, of Treasury for International Affairs. Jay Shombo, what are your thoughts on that quote? I think U.S.-China relationship is unlikely to get significantly better. But on the other hand, at the end of today, a lot of people might pay attention, there's a military exercise of China in Taiwan's trade. But at the end of today, several big issues now are behind us. One of the really big issues was China, US House Speaker meeting with the President of the Republic of China or Taiwan or whichever, you know, President Tsai Ing-wen.

5:43Now that is behind us. So actually in the next couple of months, we are actually likely to see a little bit warmer up of China-US relationship. Particularly, there's a chance of President Xi visiting US. There's also, I think both sides are talking for potential high level US official visits to China. So I think in the next couple of days, you will see the language started to toward a little bit more constructive. So I'm not surprised that the statement. On the other hand, the background is the same. U.S.-China are in a very intense competition. So if it looks good, always keep in mind, you know, the next negative news could hit, you know, on the horizon.

6:38So in terms of risk, I wouldn't read this as a significant U.S.-China relationship getting better, but it will be slightly better than the last couple of months. Yeah, and certainly a contrast from the prior administration. You mentioned what's happening in the Taiwan Strait. For those who don't know, it's an area, it's about a little over 100 miles in width that separates the People's Republic of China from Taiwan, obviously a significant strategic location. I believe we also have some senior French lawmakers visiting Taiwan today. What are your thoughts about that, particularly in relationship to the European Union's relationship with China?

7:20I'm not very familiar with European politics, but I think the president of France just visited China. And he was in the news a lot after he mentioned that he wants to reduce some dependency on the US. Actually, he also said before that the European Union wants to reduce dependency on China. I think the geopolitical background is that every country right now wants to have some independence, reduce some dependence. So even the US wants to reduce independence on Europe. Same thing for Europe as well. In terms of Taiwan Strait, I think in the narrowest areas, it's only three, four miles away from China, East Coast, where 80 % of China's people and economy lives.

8:15So I think probably a typical American couldn't quite fathom how close Taiwan is to China's main population center. So obviously people there, you know, pay attention to Taiwan. Also, the Taiwan issue is very much supported by the public. So if there is significant move away of Taiwan from the current status quo, then, I mean, let's assume the worst case scenario that, you know, there was a independence, you know, change of constitution in Taiwan, then the Communist Party has to act or else they will lose power. because the public is so much behind the party in terms of believing in one China.

9:02So, of course, you know, what is that one China? Everybody has their own interpretation, right? So there's Taiwan's official name is Republic of China, and China's official name is People's Republic of China. So which China, you know, we're talking about? But I think in Taiwan, the risk has, longer term risk has increased because China's political future is a little bit uncertain. And also the competition of the US and China, how it's going to play out is also uncertain. So over the long run, the risk is a little bit increased. But I think from the social media, it's probably too much of the immediate images.

9:49I think after today, things will quiet down a little bit. There is an election in Taiwan in January next year, the 2024 election. They run the same cycle as the US every four years. So, you know, domestically, there will be a lot of attention paid on in terms of which party. The current party is a little bit more pro-independence than the opposition party. So it will be very interesting what the Taiwanese people want in terms of in this situation. I don't see a significant war risk. That's what I tell my clients as well. You know, last year when Speaker Pelosi went to China, I think on the other hand, every country has public opinion.

10:41right? So every president has to say something to appease the local public. And that's true for China's party as well. So I think if you view it that way, then you'll be a little bit feel better in terms of the situation in Taiwan. We're going to take a quick break and be right back with more of the day's top analysis on the Real Vision daily briefing.

11:11One more news story that I wanted to point to because it's in the news today, and then we can talk a little bit more about some of the deeper, more strategic issues. There's a headline in the Wall Street Journal, and this is interesting because it touches on two of your areas of coverage. For Apple, India is the next China. This is about the notion of the diversification of supply chains away from the People's Republic of China by Apple, looking to diversify for all types of different assembly, manufacture and fabrication in India. Since you cover both of these countries, tell us a little bit about what your thoughts are on this story.

11:47Yeah, I think every country, including Chinese companies, by the way, there's so many stories here talking about companies trying to move operations away from China. Actually, Chinese companies are doing the same, too. If you talk to some of the public listed Chinese companies, because they also want to reduce the geopolitical risk. They also want to diversify. You know, they also want to be closer to where their clients are. So I think all these factors are going to drive some of the manufacturing, in particular, away from China. That trend, I think, will continue. In particular, if India is able to grow its market, its economy significantly, so this will be not surprising.

12:36On the other hand, I think some of the talk about moving operations away from China is over-germatized. China also has significant advantage in retaining manufacturing onshore. And just yesterday, Tesla is opening another mega factory in Shanghai. Shanghai is not an obvious choice. If you think about labor costs as only one issue, Shanghai is the richest Chinese city. If you think you go for the cheap labor in China, you wouldn't put your operation in Shanghai. But they chose to set up the operation in Shanghai, mainly because China also has a pretty good transportation, supply chain requires a lot of coordination closer to materials.

13:36So all those makes the total cost of producing in China still quite competitive for a significant number of high-end operations. Apple's move away from China is ongoing. But if you look at the higher-end iPhones, they are still produced in China because currently China has a labor force which is more educated than India and also a significant advantage of logistics in China. So I will say, yes, this movement will happen, including Chinese companies, but it's not going to be people's thinking that suddenly every company is moving significant operations away from China. So you mentioned then Speaker Pelosi's visit to China.

14:29I think you're referring to the visit to Taiwan in August. How significant a disruption is that? And how does the Chinese leadership, the People's Republic of China leadership, mainland China leadership view a visit such as that? I believe it's the first time we've ever had a Speaker of the House visit Taiwan. Well, actually, not true. The Speaker Gingrich, hopefully I can pronounce his name well. he also visited uh so this is back 1990s where it's been some 25 years or so yeah but uh actually at that time u.s china was in a better relationship so he also visited beijing and as one way to show you know he's he's willing to talk to uh everybody so if you use that as a comparison indeed the relationship of U.S.-China has deteriorated from, you know, more than 20 years ago.

15:22So that is, you know, everybody should acknowledge the current, you know, relationship is at the low end of U.S.-China relationship in the last 50 years. So let's talk a little bit about some of the more strategic topics that you cover in your analysis, one of which is the idea of global oil supplies being denominated in Chinese yuan rather than in simply U.S. dollars. Much talk around Russia, Saudi Arabia, and China on these fronts. Give us the overview of what's happening there. Yeah, so I think there's been so much talk about U.S. reserve currency. I don't think U.S. reserve currency is going to get away soon.

16:09So let's just put that down and say it, you know, as it's very hard to get away from dollar. And the same for China. China obviously wants to, you know, because it was seeing how Russia got sanctioned. it's now very feeling the urgency of trying to get some of the operations payments away from the dollar. So you're seeing that the central government is not buying as much as treasuries. But if you look at Chinese banks, they're still buying significant treasuries. So that's one thing. Second thing is, even though there's a lot of talk about Chinese using yuan to buy these commodities, in reality, it's still a very premature early stage.

17:06So I don't think Yuan is in any way going to be a reserve currency. But that said, we have to also acknowledge that China's central bank has been pretty good in managing Chinese currency. It is definitely one of the lowest volatility currencies among the emerging market. It's a low volatility currency. it's also where it's increasingly being used which is that's what China wanted and China can claim victory in some way let's look at it this way US dollar right now 60-50 % even if it goes to less than 50 % it's still the reserve currency but China right now is like 2 % if it gets to 4-5-6 % it's a victory you know, it's a kind of progress for Chinese currency as well.

18:02And I think they will be able to make some progress to make the Chinese yuan a little bit more usable, particularly for the emerging market economies. So let's talk, I wanted to get to a clip in just a second, because we're talking about exactly this on Real Vision. But first, you mentioned the Chinese currency. Talk a little bit about the two different rates, CNYRMB on the one hand and CHN, the so-called offshore yuan rate. Talk a little bit about what those two rates represent. Yeah, so that's the thing. Chinese currency is not easy. There's a capital control. So the government use the offshore currency market in Hong Kong.

18:51That's where the offshore Chinese currency is traded. And then you also have the onshore Chinese currency. They are usually very close. The government manages this spread pretty tightly. So I think one has to give credit that the People's Bank of China has done a very good job in terms of managing the currency volatility. Now, Hong Kong is continuing to be where China, as a place to issue more Chinese yuan denominated bonds and also to increase the exposure. Actually, I think Singapore is also wanting to get into more of these offshore Chinese yuan kind of trading business. But for now, Hong Kong is still the center.

19:52We're going to take another quick break and be right back with more of the day's top analysis on the Real Vision daily briefing.

20:03Yeah, so I've teased it a little bit and I want to talk about this clip because it's very much a posit to everything that we're talking about here right now. This is a conversation between Luke Groman and her own Maggie Lake, a piece called The Deep Dive, navigating the most dangerous investing environment in decades, coming out on 327, it looks like. Let's take a look at this conversation. By way of comparison, the United States is 0.6 % FX reserves to GDP. Why are ours so low? Because we can print dollars for critical imports. China couldn't. China's biggest imports are commodities, though. So as we have seen them gain the ability to buy oil, gas, iron ore, copper in yuan, not dollars, that structurally reduces their need to buy treasuries ever again.

20:51And if that was the case, we would expect to see the yuan remain generally steady against the dollar, which it has. I think it's down 6%, 7 % over a decade. For the quote-unquote disaster that China is in some eyes, that's pretty steady for a disaster emerging market with a banking problem, autocratic, blah, blah, blah, blah, blah, some of which is true. 46 % FX reserves, China's GDP in 2013, 26 % by 2018, 18 % now. What's the price target on that? I would say the price target on that is probably 1 % or 2%. They have the ability to buy oil, gas, commodities, anyone. And if you take away, China only runs deficits in two things broadly, commodities, semiconductors.

21:40Everybody else runs deficits against China. So if they can address their biggest, by far, deficit line item in their trade balance, they have eliminated their dollar risk, their dollar balance of payments risk. Where does that dollar payments of risk show up, it shows up as insufficient buying, foreign central bank buying of treasuries, because they were the biggest from 2001 to 2013. So this is interesting, talking about the idea of a structural reduction in the need for China to buy US treasuries. While that clip was running, I pulled up the tick data. This is the official data from Treasury that denotes by country how much treasuries foreign nations buy on a monthly basis.

22:30China, mainland China now down below a trillion dollars in holdings. This is something that's released, as I said, monthly, now moving to second place after Japan is the largest holder of US treasuries. What does it mean? Give us a little bit of context for that remark and tell us if you agree with Luke Roman's analysis about a decreasing structural desire on behalf of mainland China to acquire U.S. Treasury securities? I agree with the desire, but desire is not necessarily what, you know, China probably desire to be very, you know, not using dollar as a payment system. But the desire is far away from what's actually going to...

23:20China is going to make some progress. It's going to increase the yuan usage gradually, but it's very far away when people will completely... Will people move significantly away from dollar, including China? Yeah. So what else haven't we covered that you think is important that you believe our viewers really need to understand about what's happening in China right now? I think I mentioned in our private discussion is that I think there's very little coverage in terms of how China runs as an economy. When you read the news, most of it is about how Beijing decides what's a foreign policy. But actually how China as a command economy works, how the central government works with the local government, and why China's central government is so reluctant to take on debt.

24:18Because the central government can borrow really cheap, 3%, right, for China to borrow for 10 years. But for local government, they have to pay market rates, significant market rate to borrow. Why Chinese central government is not willing to take on local government debt? And all this really pins down how China as the economy works. I think this is not very well covered in English media. China is better thought about as almost like a corporation. You have CEO set strategy. You have different departments down there. They have a lot of autonomy. But because it's very hard to please what the local government does, you know, the central government can only do that much.

25:11so that the central government usually set a very strict budgeting process so that if there's a province, the local government is going to have to work out themselves. So the central government sets a goal the local government have to implement it on their own a lot of times. So this is underappreciated. But if you actually look through how COVID-0 is implemented, And then currently, for example, China's economy is not in a very high growth area. A lot of local government is getting rid of temp workers, cutting down expenses. Usually in the U.S. situation, the central government will be willing to take on a little bit of debt and then give money to the consumers.

26:01The Chinese government rarely does that. It doesn't use physical policy or money policy too much aggressive. And sometimes people will say, why did they do that? And the why is really on how China operates from a top-down command-based economy. And for those who don't know, this idea of a command-based economic structure differs from what we have here in the West. a market-based structure essentially means that the means and factors of production are owned by the government at the central level and then are allocated outward, as you say, for local governments to implement those policies, which is obviously a tricky balancing act if you're not trying to meet market demand, but rather a mandate that's being given to you.

26:47Yes. And the second thing I think in English media is not enough coverage is most of China is seen through Russia. When you're thinking about it, when you're reading some of the, a lot of Russian experts are asked to comment on China. And I have to say, you know, China has solved the one issue that the Soviet economy was never able to solve, which is use the price system. So in China, at least half of the economy is capitalism, is completely market-based, like in the US. In many ways, China is more capitalist. So, for example, the government, if there's a dispute between the people and the company, the government for many times sides with the companies more than with the people.

27:38So this is a very unique structure of China. On one hand, you have a command-based economy. On the other hand, you have at least 50%, if not more, economy is completely market-based, even more market-driven. So I think to understand how things work in China, you really need to have a unique perspective on China, not just seeing China through the Russian or Eastern European lens when people think about the socialism. Yeah, this is fascinating. And it's such a complex and nuanced topic, this idea of capitalism with Chinese characteristics, the idea that you do have price signals and yet you do have a very large command sector of the economy, kind of a mixed economy, not what we have in the West, but also, as you point out, not what we had in Soviet Russia and satellite states.

28:29We've got a lot of questions that are coming into us, and I wanted to just jump in and ask you a few of them because there's some really interesting ones here. The first one comes to us from YouTube. It's from TrillionX. And the question is, how do you see Aizen, this is the Association for Southeast Asian Nations, as benefiting from the expansion of China and India as new economic hubs in the world? And the second question that he follows up with, any views on the repegging of the HKD from USD to CNY? This, of course, is Hong Kong dollar repegging from dollars to renminbi. Yeah. So second question first, I wouldn't worry about the HKPAC at all.

29:10They have significant tools and also China's central bank is behind if it needs to be. So I would every time the Twitter somebody makes a issue about the Hong Kong dollar, I just shrug it off. You know, it's social media. I wouldn't worry. On the second question, on the first question, most of the movement away from China, the first mover is towards Southeast Asia, not necessarily India. Mainly because culturally, you know, it's just easier for typical Chinese entrepreneur to move toward there. But India can also benefit because a lot of Western firms is considering India as an option. But I think India really needs to, you know, pull its strap together in terms of infrastructure and also a broader industrialization.

30:04If you look at China, China has been very successful in broad industrialization, which means for almost every industry, you will have enough suppliers within the vicinity. I think India is still a couple years to go, but it can definitely benefit. Well, here's a great question that comes to us from Ralph Humphrey. They're usually great questions from Ralph. The question is, Ms. Ren, I noticed your firm has an ex-state-owned enterprise fund. What was the rationale behind this? Arguably, every Chinese company is a state-owned enterprise, so-called SOE. Give us your thoughts about this. First, wisdom tree, and full credit to my boss, Jeremy.

30:43He was the one who started this idea. We are not just for China. So we found that the whole emerging market, not just China, but India, China, Brazil, every country, the private businesses are where the growth and profitability growth came from. Now, I can comment on China. And I personally grew up in Zhejiang, where for people who are familiar is where Alibaba is based on. Zhejiang is a very unique province. Essentially, pretty much all Zhejiang's economy, I would say 80%, is private business. So for the whole China, it's about 50 % to 60%, but Zhejiang is significant. Closer to 80 % economy is private-based.