What happens in China may not stay in China
With your help, we have raised close to $210,000 (across multiple charities) to help Israel cope with the Hamas atrocities.
Your generosity has made a direct impact by helping my son Jonah’s friends from high school in Denver who were reservists in the IDF and have now returned to active duty. This money has been used to provide bulletproof vests for them and other soldiers in their units. The vests have since arrived, and here is a message from their unit in Israel to you.
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I’ll continue to share with you excerpts from the latest letter I wrote to IMA clients. Today I will discuss my thoughts on China, next week on AI.
Article available in Spanish here.
What happens in China may not stay in China
To understand what will happen in China and its impact on the global economy, we simply need to invert what happened over the last two decades.
China has had the largest housing bubble in human (and possibly galactic) history, for a decade and a half. It has lasted much longer than any reasonable analyst, including yours truly, expected it could last. One thing about bubbles is that the longer you sustain them the bigger they get and the harder they implode.
The China housing bubble is now bursting, putting immense strain on internal demand from consumers and its economy. The banking system and Chinese consumers will bear the brunt of this situation, but we’ll probably feel it across the world.It would obviously be wrong to say that all economic growth in China came from the building of ghost towns; China has tremendously improved its infrastructure and a large chunk of global manufacturing has moved there. However, capital investment as a percentage of GDP was above 40% for decades, double the level of the US. It is likely that capital investment will revert towards the US level, which in turn will reduce demand for industrial commodities (think iron and copper).
Commodities are priced on incremental (marginal) demand; the last few percentage points of demand above the inelastic (short-term) supply are the ones that set prices. Secondary effects of a decline in the demand and prices of industrial commodities will be felt in countries like Australia and Brazil that benefited from China’s ascent.There are some factors that may offset the decline in Chinese appetite for industrial commodities. Selective deglobalization is forcing companies to bring factories out of China to more friendly countries, resulting in more construction and thus more demand for industrial commodities in those regions.
The US has passed the Inflation Reduction Act, which should result in more spending on industrial goods. Lastly, India, the most populous country in the world, has one of the world's worst infrastructures, and it will be receiving upgrades.One bright spot in the Chinese economy was its tech sector (Alibaba, Tencent, and others), but Xi viewed it as a threat to the power of the Communist Party. Xi cracked down on these companies, reducing their competitiveness. Also, sanctions from the US have further damaged these businesses.
The slowing (possibly shrinking) economy, an ocean of bad debt, enormous losses of life savings on investments in ghost towns, and a broken banking system all substantially increase the risk of social instability in China.
China is becoming a more dangerous place to conduct business, as we are starting to see headlines about China not allowing capital and foreign employees to leave the country. Foreign investment into China likely peaked before the pandemic. In the past, companies emphasized their investments in China (think Starbucks, car companies); these investments will start looking like liabilities.
China, not the overheating of its iPhone 15, is the biggest risk to Apple, not just from consumption but also from the production perspective. Tim Cook has to move production out of China without China noticing it – the most difficult magic trick ever performed.China also has troubling demographics. The one-child policy, which was revoked in 2015, created a drastic imbalance between males and females and caused the rapid aging of China’s workforce, thus limiting its economic growth. (On a sarcastic note, a marriage of inconvenience between Russia and China seems like a good idea – China has a lot of single men and Russia has a lot of single women.)
We are no longer in the foothills of a Cold War with China; we are in that war. The Chinese navy may not have the same quality as the US’s, but it has definitely begun to dominate the US Navy in terms of quantity. The US has little commercial shipbuilding capacity, and we will likely need a bigger navy to counter the threat from China.
Compared to the Soviet Union during the Cold War, China has a much bigger economy that is very good at building things. This is why we are doubling down on our defense stocks, especially the shipbuilders.A Chinese invasion of Taiwan is probably one of the most important geopolitical risks. There are two lines of thinking here: A weaker Chinese economy may diminish China's ability and willingness to start a war that would further isolate it from the West. However, it is the wounded animal that is dangerous, not the fat and happy one.
One more thing: Once a quarter, I sit down with Stanley, the IMA Director of Marketing, for a video session. Stanley asks me a series of questions, which he then turns into a series of short videos that can be viewed here.
We will be having another recording session in November, so if you have any questions you would like me to answer, please send them to Stanley at sg@imausa.com.
Here are my latest Youtube videos:
Beethoven’s Triple Concerto
I wanted to share with you probably the most unique performance ever recorded (other than Rachmaninoff playing Rachmaninoff): Beethoven’s Triple Concerto. I don’t like to use the term “best” when I describe musicians, for several reasons: first, I am not really an authority, able to determine who the best is. Second, even “the best” are not best at playing their entire repertoire. And finally, music is not a sport where success is objectively measured in seconds or score counts.
By the time you become a recording professional musician you are good, but there is something that is unique (and maybe there is even a little bit of randomness) that makes you into what I call a musical giant. This concerto is performed by four giants of classical music: Herbert Von Karajan – conductor, Sviatoslav Richter – piano, David Oistrakh – violin, and Mstislav Rostropovich – cello. Listen. Enjoy!
Vitaliy Katsenelson is the CEO at IMA, a value investing firm in Denver. He has written two books on investing, which were published by John Wiley & Sons and have been translated into eight languages. Soul in the Game: The Art of a Meaningful Life (Harriman House, 2022) is his first non-investing book. You can get unpublished bonus chapters by forwarding your purchase receipt to bonus@soulinthegame.net.
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