China: A Case Study in Why We Need Governments Out of the Markets

Happy Friday!

That ice-cold beer is only 8 hours away.  First, your morning coffee.

As if you needed a reason to further distrust the intentions of the Chinese government, I’ve got one big one today: interventionism.

It’s getting harder and harder to be a free trader when it comes to China.  Defending that position against the blatant acts of interference in the markets is becoming untenable.

I wanted to believe that free trade would lead to freedom for that country.  I fear we have only empowered an authoritarian regime hellbent on the West’s downfall.

My Buddy WhatsApps Me

It’s great to still have friends “in the business,” as there’s so much I’d miss otherwise.  For instance, though I’ve lived in Asia for nearly 13 years, I’ve never become a Sinophile.

That is, I’m not a huge China fan and I most certainly don’t think Eastern ways are superior to Western ways.

Quite the opposite, in fact, despite all our flaws.

But China has one irrefutable point in its favor.  With an authoritarian government, you can get things done quickly.

Unlike, say, in the UK, where after 14 years, they got approval to add a third runway to Heathrow.  Prior to the Covid shutdown, its completion date was estimated in 2028.  Surely it will be delayed further.

Back to the Chinese and my buddy, from his perch in China.

The WhatsApp read:

From Archegos ramp to $150 down to less than $4.  Last week you had a for-profits business and over the weekend you found out it’s now a non-profit.  GOTU.  #LEGEND

I had no idea what he was talking about, so I asked.

GOTU.  Chinese online education.  Got smoked, courtesy of the CCP.

The CCP is the Chinese Communist Party.

It was time to google what happened.

First, Interventionism in General

Like socialists who often complain in the face of such disasters as Cuba, Venezuela, or Zimbabwe, “That wasn’t real socialism!” we’ve never had “real” capitalism.

Don’t get me wrong, “almost capitalism” is much better than “almost socialism,” which has brought nothing but death and destruction.

The closest we’ve ever been to unbridled capitalism was, perhaps, the early United States.  Since the end of the Civil War in the US, and certainly, since the World Wars, we’ve been in a world of interventionism.

In his A Critique on Interventionism, Austrian economist Ludwig von Mises lays his foundation on page 1:

Interventionism seeks to retain private property in the means of production, but authoritative commands, especially prohibitions, are to restrict the actions of private owners. If this restriction reaches the point that all-important decisions are made along lines of authoritative command, if it is no longer the profit motive of landowners, capitalists, and entrepreneurs, but reasons of state, that decide what is to be produced and how it is produced, then we have socialism even if we retain the private property label. Othmar Spann is completely correct when he calls such a system “a private-property order in a formal sense, but socialism in substance.”

He settles on this definition:

Intervention is a limited order by a social authority forcing the owners of the means of production and entrepreneurs to employ their means in a different manner than they otherwise would.

This is a textbook case of interventionism on the part of the Chinese government.  Usually, they’d be able to hide behind the age-old cry of the oppressor, “It’s an internal matter.”

But since many American investors, and foreign investors who trust the NYSE and SEC to properly vet companies were absolutely crushed, it’s no longer an internal matter at all.

Before I show you the charts, let me introduce you to Michael Pillsbury, whose book, The Hundred-Year Marathon, should be classified as Horror Nonfiction.

The Chinese Are Running a Marathon

Pillsbury’s book – more of a mea culpa than anything else – demonstrates in great detail how he and the Mandarins in the US government got it wrong.  He outlines five false assumptions at the beginning of his book:

    1. Engagement brings complete cooperation.
    2. China is on the road to democracy.
    3. China is a fragile flower.
    4. China wants to be – and is – like us [The US].
    5. China’s hawks are weak.

None of these assumptions turned out to be true.

And what’s worse is the analogy to China’s Warring States Period to achieve total victory over the United States by 2049, which would mark 100 years since Mao started the clock.

    1. Induce complacency to avoid alerting your opponent.
    2. Manipulate your opponent’s advisers. (Paging Hunter Biden…)
    3. Be patient – for decades, or longer – to achieve victory.
    4. Steal your opponent’s ideas and technology for strategic purposes.  (My goodness, if you didn’t hate Henry Kissinger yet, perhaps you will when you realize he handed the Chinese the keys to the kingdom.)
    5. Military might is not the critical factor for winning a long-term competition.
    6. Recognize that the hegemon will take extreme, even reckless action to retain its dominant position.
    7. Never lose sight of shi. The two elements of shi are “deceiving others into doing your bidding for you, and waiting for the point of maximum opportunity to strike.”
    8. Establish and employ metrics for measuring your status relative to other potential challengers.
    9. Always be vigilant to avoid being encircled or deceived by others.

I know what the economic theory says: free trade.  But why would you strengthen those who want to destroy you?  I never got a good answer for that question.

So What Did the CCP Do?

On Saturday, July 24th, China released new regulations that ban companies that teach school curriculums from making profits, raising capital, or going public.

So my buddy was spot on when he wrote the CCP turned all these companies into non-profits.

From Yahoo Finance:

Beijing on Saturday published a plethora of regulations that together threaten to upend the sector. The nationwide crackdown stems from a deeper backlash against the industry, as excessive tutoring torments youths, burdens parents with expensive fees, and foment social inequalities. Once regarded as a sure-fire way for aspiring children (and parents) to get ahead, it’s now also viewed as an impediment to one of Xi Jinping’s top priorities: boosting a declining birth rate.

Have a look at these charts:

GOTU’s run-up was due in no small part to Bill Hwang’s infamous Archegos hedge fund taking leveraged long positions in the stock.  His fund’s meltdown led to a big decline in the shares subsequently.

TAL’s stock followed a similar trajectory, but its fall is not as egregious as GOTU’s.

EDU also got crushed, as one would expect.   Operating losses will persist for years.

These are NYSE-listed stocks.  Not Hong Kong, Shanghai, or Shenzhen listed.  It’s outrageous that governments can just pull investors out of their private holdings this way, especially across borders.

And it’s not just Mom and Pop.  Singapore’s sovereign wealth funds, Temasek and GIC, also have to weather the hit.  Sequoia Capital and Tiger Fund Management, a venture capital firm and hedge fund, respectively, declined to comment on their decimated holdings.

Chinese companies Tencent and ByteDance will also suffer losses.

All this begs the question: are you comfortable holding Chinese stocks?

Do you think the CCP is losing sleep over this?

It’s probably just another step in the plan.

Perhaps international diversification increases return while lowering risk.  But I’d advise you to do that in jurisdictions where the rule of law is taken seriously and isn’t arbitrary.

Have a great weekend!

All the best,

Sean

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