The Problem With China

| September 06, 2019

Perhaps it is wisdom that has allowed me to recognize the fallacy of so many of my youthful beliefs. I truly thought that the economic liberation of the People’s Republic of China, under Deng Xiaoping, foretold a future of greater liberty, prosperity, and peace for China and the world. Eventually, I believed, mainland China would become more like Hong Kong, or follow the path of South Korea, where strongman rule gave way to liberal democracy. The 1989 Democracy Movement showed that Chinese youth craved civil rights, but the Tiananmen Square Massacre demonstrated the power of communist rule to crush them. Today, we see similar youth engaged in protracted protests against the creeping power of the communist mainland.

Prosperity has come about, and the world in general is more peaceful than during the Cold War, but China has grown more menacing. Russia remains a power only through its possession of nuclear weapons. Otherwise, it is an economic basket-case. China is very different from the Soviet Union, since it is not an amalgamation of separate nations, races, and ethnic groups held together by force. When the USSR collapsed, the Baltic States became independent, Poland returned to being Poland, and so forth. The giant nation of China is composed of an ancient civilization that is racially and ethnically homogenous. The Han Chinese form the world’s largest ethnic group and make up more than 90% of the country’s population. These conditions enhance the Communist Party’s ability to stoke nationalistic aggression towards a common enemy, whether real or perceived, and thereby deflect criticism from itself. The Canadians are experiencing this today with the arbitrary arrests of Canadian citizens in China. Recently, the stories about the treatment of the nation’s ethnic and religious minorities are reminiscent of those recounted during the Cold War by Alexander Solzhenitsyn, Armando Valladares, and Jorge Valls.

In July, the Globe and Mail’s Nathan Vanderklippe wrote an 18-page report that recounted the personal stories of individuals held in the camps of Xinjiang, and the fear rampant within the population of Kazakhstan. A typical story comes from Gulzira Auelhan, a Chinese woman who is an ethnic Kazakh. While traveling to visit her ailing father, the Chinese police arrested her and sent her to a Xinjiang reeducation camp where she was held for 437 days, forced into slave labor, tortured, and indoctrinated into the ideology of the ruling Chinese Communist Party. As Auelhan recounted to Vanderklippe, “before she was shocked with a stun gun to the head for spending more than the allotted two minutes in the toilet, and before she was handcuffed for 24 hours because guards accused her of letting another woman participate in religious washing, and before she was forced to make winter gloves for two pennies a piece – before all of that, Gulzira Auelhan remembers a Chinese police

officer telling her she needed to be educated.” 1

These stories out of China have concerned me for more than ten years. Trying to invest ethically is always a challenge, but China is as big a challenge as it is a country. Engagement with China has lifted many millions out of poverty. Chinese people do travel abroad now and many own property in places such as Canada and South America, just in case. About 200,000 Chinese tourists visit the Province of Québec each year. Throughout the world we have similar quandaries, since low-pay jobs are often better than the no-pay starvation that came before. Still, few places pose as big a challenge as China. James Kynge, of the Financial Times, points out that the United States has “signed several bilateral agreements with Beijing since the early 1990s to protect American intellectual property in China, only for each one to be violated in spectacular fashion by Chinese actors.” Additionally, “in 2015 alone, US losses were worth up to $540bn – more than the entire US trade deficit with China.”2 This is a massive problem that is not limited to the United States.

I have avoided for more than 15 years investing in China after learning about the commissary-like system that operates there. To understand it, think of The Grapes of Wrath, where workers slave for years before discovering that they have been charged by their employers more for food and housing than they earn. If they quit, they owe the company money that they cannot pay and have no legal recourse. Within the investment world, one of the greatest challenges is indexing. When Chinese allocations are raised within the various indexes, this triggers a reallocation in passive funds. The result can be a massive flood of money into China. According to Frances Yoon and Shen Hong, writing in the Wall Street Journal, “JP Morgan Chase & Co. plans to add Chinese government debt to its widely followed indexes.” 3 The result will be large flows of money from the United States to a country whose leadership views itself as an adversary, not a competitor. I have attempted to avoid this where possible. I can still hope that my youthful idealism will be realized. In the meantime, I am interested to hear what clients think about the subject, and whether they want us to do more or less where it concerns China. Personally, I’m rooting for the protestors, but their chances do not look promising in the long term.