Global investors should stop funding China’s geopolitical ambitions
International investors who invested trillions of capital in stocks of Chinese companies suffered their biggest loss since the 2008 economic crisis. Between Friday July 23 and Monday July 26, the Golden Dragon China Index plunged more than 15%. Other major China-focused stock indexes saw similar declines, and many of them are now in negative territory for the year. The culprit of such a massive loss is none other than the Chinese Communist Party (CCP).
The CCP has launched a series of crackdowns against China’s biggest tech companies, private education companies, and food delivery companies in recent months. It all started with the abrupt cancellation last November of the initial $ 37 billion public offering of the subsidiary of Chinese tech giant Alibaba, Ant Group, after its founder Jack Ma criticized Chinese regulators during the a conference. Ma hasn’t made many public appearances since then. Some suspect he is under house arrest. Investors inside and outside China have faced losses of several billion dollars.
In April, Chinese regulators fined Alibaba $ 2.8 billion over the government’s so-called “antitrust” investigation. This month, Chinese regulators summoned China’s 34 biggest tech companies, including ByteDance, the parent company of the popular TikTok app. They have given executives of these companies over 100 compliance items, covering antitrust laws, data, advertising, pricing, and more. After the meeting, the 34 tech companies issued similarly worded public statements pledging to abide by the government’s antitrust laws and take more responsibility for supporting China’s economic and social development. It was total surrender.
Chinese regulators passed a data security law in June. While the Chinese government has asserted that the purpose of the new law is to protect the privacy of Chinese citizens, in reality, the law strengthens the access of the Chinese government to all the data that Chinese companies and multinationals collect in China. . The law has become the Chinese authorities’ new tool to continue cracking down on tech companies and Chinese citizens.
After Chinese rideshare company Didi was listed on the New York Stock Exchange at a valuation of $ 68 billion, the Cyberspace Administration of China (CAC), a regulator reporting to CCP chief Xi Jinping, accused the company to engage in illegal activities collecting and sharing user data. In July, the ACC ordered Chinese app stores to remove Didi’s app and launched a cybersecurity investigation into Didi. The crackdown has caused Didi’s share price to drop by more than 30% in recent weeks. The company now faces legal action from international shareholders.
But it turned out that the CCP’s crackdown on some of China’s most successful companies had only just begun. Bloomberg reported last week that the Chinese government announced new rules to curb Chinese out-of-school tutoring companies, including forcing them to become non-profit organizations, limiting the fees those companies can charge, and making them free. prohibiting raising capital and obtaining foreign ownership. For the Chinese private tutoring industry, these new rules amount to a death sentence. New Oriental, one of the largest tutoring companies in China, saw its Hong Kong-listed stock price drop more than 80% in two days. An analyst from JPMorgan Chase & Co. concluded that the new Chinese rules “make these stocks virtually non-investable.”
Bloomberg estimates that the recent Chinese government crackdown on China’s technology and education sectors wiped out $ 1.5 trillion. Even investors who do not directly own these stocks have likely suffered losses because many mutual funds hold these Chinese stocks in their investment portfolio. The speed of China’s policy change and the scale of the financial losses were unprecedented.
There are indications that the crackdown is not yet over. The Chinese government then reportedly put its ax into the gaming, healthcare and real estate industries.
Little recourse for global investors
Unfortunately, global investors have little recourse to hold the CCP to account and recoup their losses due to the type of Chinese company stocks they own. As Beijing bans foreigners from taking over what it sees as strategic sectors of the Chinese economy, many large Chinese companies have established offshore holding companies or variable interest entities (VIEs) to raise funds. capital from foreign investors. Joseph Sternberg of the Wall Street Journal explains that owning shares of these VIEs is very different from holding normal shares:
The Western investor owns nothing, since ownership of VIE does not result in a claim on the assets of the Chinese operating company. The Western investor cannot make any request to the management of the Chinese company because, in the absence of an equity stake, there is no mechanism to influence or change the direction. In the event of a dispute, no one can guarantee that a Chinese court will enforce the contracts between the Chinese operating company and VIE owned by Western shareholders.
In summary, these VIE shares offer foreign investors minimal legal rights or protections. But many investors played down those risks for years because they bought the Chinese growth story that the CCP sold them. China’s booming economy has fooled global investors into believing the CCP is their best friend. No one imagined that the CCP would be ready to destroy an entire industry with sudden policy changes.
Why has China made such abrupt changes?
There are several explanations for recent CCP regulatory actions. First, some Chinese companies and their founders have become too powerful for CCP leader Xi’s liking. As a dictator, Xi viewed any criticism as a threat to his power. He therefore suspended the Ant Group’s public offering after Ant founder and principal owner Ma criticized Chinese regulators. Xi made Ma “disappear” to show Ma and the other Chinese tycoons who is really in charge.
Second, the CCP, under Xi’s leadership, has shifted its priorities. Since the CCP initiated economic reform in 1980, the CCP’s top priority for three decades has been to grow the Chinese economy to stay in power. However, as Xi consolidated all the power in his hands, he made it clear that his priorities were national security and social stability, which he said are crucial in keeping himself and the CCP in check.
Xi cracked down on tech companies to turn over the big data they collected to the government and help the government control the Chinese people. Xi has restricted private tutoring companies as a way to deal with China’s demographic crisis caused by the CCP’s brutal “one child” policy. This crisis threatens economic growth, which in turn threatens the power of the CCP. Some Chinese parents complain that the rising cost of education is one of the reasons they don’t want to have more children. Xi therefore hopes that controlling private education companies will reduce this cost and thereby increase the population.
Xi will sacrifice anyone, any company, or an entire industry if it serves his priorities.
Finally, Xi, like his CCP predecessors, treated the capitalists and their money as mere tools to help the CCP achieve its economic and political goals. For decades, the CCP has relied on foreign investment to fund technological progress and industrial development in China, in the hope of returning China to the status of a dominant world power.
But Xi also has a very cynical view of capitalists. He sees them as people without ideology but only motivated by greed. Therefore, Xi is convinced that no matter how much he hurts them financially, the capitalists will not stop investing in China because the Chinese market is too attractive for them to give up. Xi can quickly point to Western companies that bowed to him, like Apple, Disney, and Nike, as sources of his trust.
Xi clearly doesn’t care about the financial pain he inflicted on global investors as long as he achieves his goals. It is time for international investors to finally learn the lesson that the CCP has never been their friend. They should stop funding the geopolitical ambitions of the CCP. A much better way for investors to achieve long-term financial growth is to invest in countries that govern by law and protect individual liberty and property rights.