China Challenging Washington Consensus (again)

1 min
February 28, 2023
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Having resisted the Washington Consensus development model, China now seeks to challenge its political narrative too.

Most people find the consensus a comfortable place to be, but as investors we know it is important to challenge it, after all, if the consensus is in the price, then we need to explore where, or indeed if, it might be wrong. And by extension where we might be. In the context of our ‘Three tribes’, the consensus among the short term leveraged traders is the least ‘robust’, it serves a purpose (usually to get the next person in so that they can get out) and can easily flip 180 degrees within a week ,which is why we refer to them as ‘noise traders’, their views being far more about market mechanics than any insight into the fundamentals. The medium term asset allocator by contrast is generally content to remain ‘with’ the consensus to limit their own risk – in Keynes famous phrase deeming it “better to fail conventionally”. As such, they are a good guide to where prices currently ‘are’, but will shift their allocation as their benchmark shifts, creating a form of momentum that is often exploited by the traders. Watching how medium term consensus shifts (from deep recession to mild recession for example) is an important part of asset allocation. Finally, the longer term investors are often seen as contrarian – buying the dips in bull markets and selling the rallies in bear markets to exploit the market mechanics of the other two tribes, but their consensus view is more linked to the even longer term and slower moving economic and political consensus, which is the slowest moving of all.

It is against that background that we consider the role of China, which is increasingly to challenge this latter economic and political consensus, with ripple effects up through markets. In our recent video piece, we made the point that for the last decade or more the west has made assumptions about China that proved to be very wrong, the consensus view being a projection of what the west thought China should do, rather than what China itself thought it should. Indeed, even when China told us in its five year plans, we took no notice and were then shocked when it carried them out. When it told us of ‘The China Dream’ we decided that meant it wanted the American Dream of consumer borrowing and imports of western products. It didn’t. And when it told us about Common Prosperity, which is essentially Socialism, we decided that it meant it wanted to sell off state assets and embrace, privatisation, private equity, hedge funds  and the type of leveraged, rentier economy we have in the west. Again, wrong.

These policies have a name – The Washington Consensus – that describes the policies that the west has applied to Emerging Markets for the last fifty years or more and the fact is that the west was blithely assuming that China would be the biggest emerging market of all – which is why the Multi-Nationals and the Financial markets got so excited. Briefly, the template involved a floating exchange rate, open capital markets and foreign ownership of capital, factories etc. Then a loan from the IMF  or World Bank would be accompanies by some requirements for ‘reform’, usually industrialisation of agriculture allowing workers to leave the countryside to work in factories owned by western corporations. Plantation-style agriculture for export would then require importation of basic foods from western agricultural producers, while the cheap labour in factories produced low margin goods for export. Western financiers then lent (in $) to local banks to fund consumer borrowing, allowing a housing boom and increased consumer spending. High margin goods naturally had to be imported from the west, while the stock and bond markets boomed as the shares of the banks, cement companies and other infrastructure plays like Telecoms soared, making billionaires of the politically connected owners. The result was always the same; boom, then bust, leaving the emerging markets still not emerged and the public assets now owned by Wall Street as the caravan moved on.

China resisted this template, even though many western corporates and financiers convinced themselves otherwise after their ‘success’ in South and Latin America, South East Asia and Eastern Europe. Instead, China followed a more ‘North Asia’ mercantilist model (ironically the same as that followed by Germany and the US themselves in the past) and specifically did not allow foreign ownership, open capital markets or a freely floating exchange rate.

The reason for revisiting this 'resistance' is that over the weekend, China appears to be resisting another form of Washington Consensus, this time the Political Consensus narrative around Russia, Ukraine and China itself. In a quite unprecedented series of pronouncements and publications over the last few days, the Chinese government have essentially set out their alternative narrative to the one being promoted from Washington. While ostensibly tied up with a series of peace proposals for Ukraine, there is clearly some bigger picture messaging going on too. One does not have to look much beyond the headings of the paper entitled US Hegemony and its Perils to get a feel for the content.

I. Political Hegemony—Throwing Its Weight Around

II. Military Hegemony—Wanton Use of Force 

III. Economic Hegemony—Looting and Exploitation

IV. Technological Hegemony—Monopoly and Suppression

V. Cultural Hegemony—Spreading False Narratives

Importantly, none of this is aimed at changing the mind of anybody in the west - which is a good job as not a single mainstream western media source is reporting it. Instead, it is aimed at what some are referring to as 'The Global South', the rest of the world outside of the NATO + Japan and South Korea bloc, who are far from convinced by the western 'narrative' on anything, but certainly on Ukraine and most definitely on China. As an illustration, consider the latest vote on a 'new international economic order' at the UN as shown on this map, where 123 voted in favour (green) and 50 against (red). Essentially there are the so called 'golden billion' in red on one side and an equivalent number of people in China on the other. Plus the rest of the world. China's more assertive narrative is aimed squarely at the other 122 green countries.

This is the new bi-polar world

source Geopolitical economy report.

This is not a question of right or wrong on the vote (it has been pretty consistently like this for decades), rather an illustration of the size of the 'opposition bloc'. Now with the developments in Russia - in particular the seizing of Russian FX reserves - and the emergence of China to present an 'alternative vision', the battle lines have been drawn and investors would do well to listen to what the alternative voice being presented is saying, as well as who is listening to it. (It is one reason why we read the Global Times, just as we might read Foreign Policy the in house journal of the Council of Foreign Relations to get the US insider view.) As to China's latest slogan? "Time and momentum are on our side", which we can't help thinking is pitched as an equal and opposite to where they see America right now. Investors should take note.

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The 99 States of America

The multi-polar world emerging is producing a new 'Dollar Zone' of NATO plus Japan and S Korea. Investors need to start thinking what this will mean for capital flows.

First slowly....then all at once.

SVB was a shock as everyone assumed everyone else had done the due diligence, but in reality it is a simple story of a bank that became a bond fund and failed to manage its duration and funding risks only to be hit with the equivalent of a redemption as its almost entirely corporate deposit base asked for their money back. By contrast Credit Suisse is hardly a surprise, but coming at the same time, and also in options expiry week, helped to create an exaggerated sense of a banking crisis. There isn't one. Both banks are the collateral damage of the shift to a new New Normal, where interest rates are set at 'normal' levels and normal companies can make normal profits (while great companies can make great profits). Investors should use the sell off from expensive end of fair value to cheap as an opportunity to renew or place their bets on the likely winners under this new paradigm.

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