What caught my eye?v.65:Is China ‘a shining city upon a hill’?

In the latest issue, we ask why the rest of the world increasingly looks like China.

In the ’80s, Reagan had frequently compared the US to a biblical ‘city upon a hill”and for him, it was meant to represent the world’s best and highest aspirations.

Why would we describe China as today’s ‘shining city upon a hill’? Reagan’sview of the US as “a tall, proud city... teeming with people of all kinds living inharmony and peace... with doors open to anyone”, no longer truly describes USreality. Neither does it describe China. However, China more than any othercountry, may illuminate the most likely immediate future for all of us.

What makes China unique is its lack of separation between fiscal, monetaryand banking policies as well as blurred distinctions between private and publicsectors. We maintain that most other economies are likely to embrace similarpolicies, as there are few other (if any) socially palatable alternatives to thecurrent secular stagnation. We reside in a world where a financial ‘fireball’(~US$300-600 trillion of financial instruments or 4x-8x global GDP) constantlythreatens to crush the underlying economy, which has long passed thepoint of no return. Over-financialization and technological shifts ensure thatproductivity remains constrained, precluding any deleveraging. In the absence ofstronger productivity, piling up financial instruments leads to inexorable erosionin return on capital, whilst structural shifts depress ‘returns on humans’.

China’s business model provides one possible evolutionary answer. Thewidely debated ‘helicopter money’ and full integration of fiscal and monetarypolicies has already been in existence in China for at least a decade. Why wouldanyone imitate it? In our view, there is no choice. The third Industrial revolutionand financialization are radically altering global economy and the role of capitaland labour, whilst also erasing most market signals. Although new technologiesdo create their own demand, it is a highly dislocating process, eliminatinghitherto successful business models, dissolving labour markets and alteringsocieties. China’s state-capitalism and political economy offer a potentiallyattractive answer (an aggressively proactive public sector to soften transitionpains). Monetary & fiscal spigots simply open and funds flow. There is however aprice to pay—atrophy of free markets and private sector signals and ultimatelyfurther misallocation of resources. However, the alternatives could be worse.

Whilst most economies are already emulating China, LT structural trends areeven more disruptive. In this new world, ‘brains and knowledge’ would count forfar more than capital or labour. ‘Flexible & Soft’ would be a recipe for successwhilst ‘Inflexible and Hard’ presage declining returns. Value would even morethan usual concentrate in ‘zero to one’ (technology & innovation), leaving littlefor scale players (‘one to n’). It means that over time countries (such as US)with more flexible economies and stock of knowledge are likely to win, whilsteconomies wedded to traditional infrastructure and supply chains would lose.

The move towards ‘flexible & soft’ is already becoming a strong trend.

What does it mean for investors? Ability to achieve quality growth in suchuncertain world should become ever more valuable. The same applies todisruptive Themes. We continue to advocate avoiding public sector and tacticalmacro calls whilst focusing on ‘Quality Sustainable Growth’ and ‘Thematics’.

Both portfolios continue to outperform (~3%-4% YTD), despite low stockturnover and strong quality bias, illustrating that in a non-mean reversionary andpublic sector-driven world, conventional cycles and sector rotations (i.e. cyclical,defensives, income, value etc) are unpredictable with limited investment value.