Chinese Debt

China has been in the news lately from trade wars and a tightening of power, also navigating the financial crisis and starting the belt and road initiative. The market has polarized viewpoints of where China is headed in this century. While some feel that China will become a rising threat as it grows into the largest economy in the world, others feel that the authoritarian system will collapse under the weight of free markets. The reality is more nuanced and will be somewhere in between.  The polarization of China's future is a result of absolutism that works in politics but does not make for good investment strategy. We will use these polar theories as a basis for our theory and work our way back to an investable position somewhere in the middle.

​China is taking over the global economy:

Trade talks about intellectual property theft and unfair sanctions make it easy to see this as a war against the United States, on an economic front. I do agree that something needs to be done about the way foreign companies are treated in exchange for access to the Chinese market, this has been a long time coming. All free market companies that wanted to tap the gold mine of Chinese consumers must abide by the Chinese rules. This usually meant partnerships, technology sharing and only having minority positions in Chinese companies. All these companies had to go to China to look for growth to remain competitive and increase shareholder value, so they obliged. China is at a point where they are looking to move up the value chain which would seem to be direct competition with the developed world. This is a threat, but not one that came out of nowhere. There will no doubt be more challenges to China's expansion as the centralized government will have to start playing by international rules more often in the services sector. In the long run, China will become a competitive force around the world and will have to be accounted for by countries and companies.

China's government will collapse from the free market:
The communist government is trying to keep the benefits of a free market economy open while maintaining rule over social policies. Not allowing companies to fail in order to keep unemployment from creating unrest will eventually prove unsustainable. The high growth rates currently seen are bound to drop off, and as the government tries to stem spending and overcapacity (from the companies unable to fail) prices will be depressed, putting solvent companies into 'zombie' status as well. This cycle will continue until the government is propping up the economy by itself, running the country's finances into the ground. This will cause the social net of the country to break down and social unrest will lead to revolution and a collapse of the government.

The reality in between:
The rise of China has been remarkable and there are no signs that this trend is going to end. Growth rates are enviable, and the market is not struggling with the socialist government increasing censorship or scaling back sectors to prevent overcapacity. The transition of Xi Jinping to the 'party leader for life' hasn't caused any upheavals, in fact, having a longer term central ruler could allow the state to take the necessary solutions to some of their issues that wouldn't be possible in an election cycle like we see in western countries. Due to this, it is good to look at China as a focal point for growth into the foreseeable future.

Knowing what is going right is one part of the equation, the other is to know what to keep an eye out for that could jeopardize the longer-term prospects of the country. While growth has been strong in the country, a lot of it is fueled by debt. This debt load is one of the largest factors to keep an eye on when assessing long-term risks in China. By having the ability to wait out geopolitical and cyclical storms, the government will be able to successfully navigate South China Sea concerns and temporary slowdowns in the economy. Debt is where there is cause for concern, by having too much debt on the books, smaller issues could turn into larger ones if payments become unmanageable. With bold investments like the belt and road initiative, China will be loaning out money to countries to make this a reality. The amount of money borrowed by these countries (usually from China) to build the infrastructure will have to be paid back or it could put China into a precarious position. Acting in these countries will create a costly precedent of intervention like we see with the US, with China spending even more money to ensure stability in all the countries in which it has interests. The other options are to assume that some of these loans will go bust or create a constant need for bailouts and investment (this could be why China created the Asian Infrastructure Investment Bank).

Overall China should continue to be a big factor in any long-term portfolio, as part of an emerging market mix. The question is a matter of how much should be invested in the country and what to look out for in terms factors that could affect growth prospects. Keeping an eye on key factors like the debt load, overcapacity, and the financial markets in order to look for whether China should be invested into as part of a weighted emerging market allocation or have less money allocated to wait for a better opportunity to invest.