Small and Medium-sized Business Downsizing in China

The South China Morning Post is beginning a series about the China economy.

Chinese President Xi Jinping warned on January 21 that the Communist Party needed to pay particular attention to the risks to social stability from rising economic problems, as evidence increasingly suggests that the nation’s employment situation is deteriorating rapidly, particularly among small and medium-sized businesses.

An important aspect of this situation in China is that the prospect of a significant economic downturn is not just that there could be a recession or even an “economic hard landing” but that it could lead to significant social unrest. The article goes on to give examples of companies that have reduced their labor forces by more than 75%! The end result is survival, not repayment of debts or prosperity.

Chinese economic statistics have always been suspect, so anecdotal evidence is often relied upon to get an accurate picture of what is going on. What is known is that China has taken over a lion’s share of production in many industries from the rest of the world. Seventy percent of world electronic production capacity now is in China and the risk of a permanent trade war is taken very seriously, especially considering the amount of debt that companies and whole industries have taken on. As noted in the South China Morning Post article, many smaller Chinese businesses got into the habit of simply borrowing, expanding, and having enough money to service their debts. Now the world is changing and companies are downsizing very rapidly.

How Do Job Cutbacks in China Relate to Your Investments?

China ADRs

The first point of concern would be investments that you might have in Chinese companies. Investing.com lists 403 Chinese companies with ADRs available in the USA. If you are invested in any of these, you need to do your fundamental analysis and make sure if you want retain the investments in your portfolio or not. If you do not believe that you can do an accurate job at this because of sparse data, it might be better to sell.

Offshore Investing

The next issue is any other investment you might have offshore from the USA. We recently wrote about how offshore investment in Brazil was starting to look promising with the new government. But, Brazil and other exporters of raw materials will all have the same problem if China experiences a significant economic slowdown and quits importing at its current rate. The resource curse of boom and bust cycles is inherent in commodity exporters. There are relatively secure value investments offshore but you need to do your homework to find them and to assess their intrinsic value.

Direct Foreign Investment as a Guide

To know where to put your money offshore, a useful resource is the World Bank’s Foreign Direct Investment page of statistics. The most recent figures show that worldwide foreign direct investment was $2 Trillion in 2017, down from $2.5 Trillion in 2016. China received $168,223.58 million ($168 Billion) in 2017 versus $354,828.00 ($355 Billion) for the USA.

Meanwhile the European Union as a whole received $604,920.21! And Brazil came in at $70,685.05. It would appear that as the world economic situation worsens that money is flowing into developed economies more so than developing economies. Since this is where the smart money is going, smart investors will probably follow suit.

The World Bank updates these figures every year so it is always a useful resource for those wanting to invest offshore.

How Investments in the USA Will Be Affected

An old friend of ours recalled when the stock market crashed in 1929 and all of the businessmen in his small Midwestern town were not worried. New York was a long ways away and what happened there would never affect the prices of corn, soybeans, beef, pork, or eggs. Three years later our friend was burning corn cobs in his stove to keep the office warm because corn was cheaper than coal. The US Congress has picked a trade war with the Smoot Hawley Act and the US economy entered the Great Depression.

If you think that what happens in the country that consumes more natural resources than anyone else does not matter in the rest of the world you are dead wrong. Companies like Boeing, 3M, Procter & Gamble, Deere, Caterpillar, Apple, and many many others derive a substantial portion of their incomes from trade with the rest of the world and with China in particular. When a company in China lays off 700 of its 1,000 workers, those workers have no jobs or take lower-paying temp jobs. The effects ripple through the economy and more companies lay off more workers and the downward cycle continues. The growing Chinese economy has been a consumer of many Western products. We in the West would like to have more access their economy and that is a lot of what the looming trade war is all about. The risk is that China will not open up to the West but will look inward instead. Apple already downgraded its projections for China for the coming year. This is how job cutbacks in China relate to your investments if you have multinationals in your stock portfolio. Trouble in China will spread to many developing nations and sales of goods by the USA will suffer.

The one bright spot for the USA and other developed economies is that foreign direct investment and cash via the Forex market will seek safe havens in these economies.

What Can You Do?

Some time back we wrote about how to invest without losing any money. As economic risks increase a wise investor will rotate part of his or her holding into AAA bonds (Microsoft and Johnson & Johnson, US Treasuries, and even CDs at the local bank. Any stock investments should be value investments until the economic situation in China and elsewhere improves. If the economy and market worsen, there will likely be quite a number of deep value investments for those willing to do their homework.

How Do Job Cutbacks in China Relate to Your Investments? PPT

China Moves to Adjust Its Economy

China helped lead the way out of the financial crisis and the Great Recession by doubling down on their investments in both infrastructure and industrial capacity. Nations, like Brazil, saw huge benefits as China’s industrial machine consumed more and more raw materials. The price of oil skyrocketed making not only OPEC happy but also Russia and Brazil. China had been expanding its state-run economy for years and steadily increasing its customer base to span the globe.

But, as large as the world economy is, it is finite. And, the industrialized economies of the world got tired of seeing jobs and whole industries pivot to China. China had over-built its industrial base and now saw a substantial slowdown in growth, closing factories, and even labor unrest. A slower Chinese economy needed fewer raw materials and the emerging markets suffered.
Rich Chinese saw the slowing of China’s miracle expansion and started a capital flight that still threatens the country’s economy. China’s economy is now under pressure due to a trade war with the USA.

Russian Adventurism Brings Sanctions

In 2014 we wrote about investing in Russia after the annexation of Crimea and support of separatists in Ukraine in parts one, two, and three. Russia was hurt by the fall in oil prices that year and is still hurting. Then, the EU and USA levied economic sanctions that greatly reduced investment in Russia and the ability of Russians to use the international banking system. With Russia meddling directly in elections in Europe and the USA, it is unlikely that these sanctions will be lifted any time soon.

Political and Economic Chaos in both Brazil and South Africa

When the BRICS first met officially in 2009 the Brazilian president, Lula de Silva, was commonly called the most popular politician on the planet. Today he is due to start serving a 12 year prison term for his involvement in governmental corruption. Jacob Zuma was the president of South Africa and was recently forced out of office by his own political party. Along the way the focus was no longer the spectacular growth of Brazil but Brazilian bankruptcy. South Africa’s GDP was $400 Billion in 2011 and $295 Billion in 2017.

Trade War and a Strengthening US Dollar

Trump did not start a trade war with nations like Brazil. But, if and when a trade war slows economic production in China, Europe, or anywhere, the emerging markets get hurt. A couple of years ago we wrote about the resource curse of boom and bust cycles. Nations like Brazil, Russia, and South Africa are rich in natural resources. When demand goes up they prosper and when demand goes down they suffer. And, another result of the trade war ramping up is that the US dollar is getting stronger. The dollar is perceived to be a safe haven currency and the US Federal Reserve is steadily raising interest rates. Investors are leaving emerging markets to flee to dollar-denominated assets, and to flee to the USA where markets are still healthy.

Why Are Investors Leaving Emerging Markets? PPT

The veracity of China’s economic data has been increasingly questioned as the slowing pace of the country’s growth has startled the world. And a new investigation into the official who oversees the numbers is unlikely to inspire confidence.

The Communist Party’s anticorruption commission announced late Tuesday that it was looking into the head of the country’s statistics agency over what it called “serious violations.”

It is unclear whether the investigation into the agency’s head, Wang Baoan, who became the director of the National Bureau of Statistics of China last April, is related to his current role or to his previous one as vice minister of finance. The commission did not release any further details about the inquiry.

Recently minor officials admitted to previously inflating economic figures. The assertion of the government was that since the economy had not really been growing as fast as reported, the decline should be seen as less severe! China needs to get its economic house in order and rather than dealing with the issues at hand they are choosing to kill, or at least imprison, the messenger of bad economic news.

How Bad Is the News?

Some economic estimates put China’s current economic growth at half the government figures at 3.5% instead of 7%. That sort of fudging is what keeps many from investing in China and doing business with Chinese companies. The Economic Times suggests that China may underestimate growth during economic booms and overestimate it during downturns.

The bureau is supposed to provide China’s leaders with an unvarnished assessment of the country’s economic strengths and weaknesses, even while reassuring the public about growth and maintaining consumer confidence. It is also supposed to release enough detailed and accurate information for investors and corporate leaders to make sound decisions about economic and financial prospects.

China needs to be working from unvarnished data if it is to deal with its economic and social issues. Killing the messenger of bad news is a short term solution to confuse the public as to who is really at fault for China’s current problems.

China, Asia, Europe and North America

Every time there is a market disruption in North America, China, the rest of Asia or Europe the bad news follows markets around the globe. Of late the bad news has repeatedly come from China. The answer to the world’s concerns about the Chinese economy is not to kill the messenger carrying bad economic news but rather that the Chinese government become more transparent and move toward open markets. In that regard The Street reports that China may open its market to foreign investors in an attempt to stop the plunge in stock prices.

China is running out of ways to prop up its stock market. So government officials are weighing whether to go after a rather surprising source of funds: individual foreign investors.

Considering the recent implosion in Chinese stocks, the effort may resemble trying to buy insurance while your house is burning down. But China is desperate to bring in more foreign capital to support private enterprise, so it’s thinking of doing it anyway.

So long as the leaders of China present scapegoats when things go wrong, instead of taking responsibility at the top, foreign investors will be well advised to be wary of investing in the casino-like Chinese market.

Is China Going to Kill the Messenger Carrying Bad Economic News? PPT