Wall Street doubles down on China
For the men, and occasional woman, who run America’s most powerful financial institutions, these are the best of times: blowout earnings in the last quarter, a surge in mergers and acquisitions, and lucrative trading thanks to volatility generated by an expected turn in the interest rate cycle.
Wall Street has also enjoyed a fair wind, nowhere more so than in China. Goldman Sachs has just joined Morgan Stanley and insurance giant Chubb in winning regulatory approval for taking full control of its joint venture with Chinese partners – an apparent vote of confidence in the progressive liberalization of China’s financial sector.
This happy convergence of financial interests contrasts with an increasingly hostile geopolitical environment. The U.S. and China find themselves diametrically at odds over Hong Kong, Taiwan and trade. A technology arms race is underway between the U.S. and China that extends from artificial intelligence to sophisticated weaponry, highlighted by Beijing’s recent test of two hypersonic missiles.
In this new age of strategic competition, says one Wall Street boss mindful of his exposure to China, “It sometimes feels like we are operating behind enemy lines.”
For the past 20 years, starting with China’s entry into the World Trade Organization in 1999, conventional wisdom dictated that the economic opportunities outweighed the political risks of doing business in the Chinese market. Even when Beijing insisted on its own companies preserving majority stakes in joint ventures or gaining access to highly prized intellectual property, Western companies grudgingly went along. China was simply too big to ignore, and Asia was the source of future growth.
U.S. policymakers like Hank Paulson, the ex-Goldman Sachs boss turned U.S. treasury secretary, also judged that China’s engagement with Western capitalism would slowly change attitudes, perhaps one day leading to gradual political liberalization. Such hopes have proved vastly inflated. China has adjusted the global economy on its own terms while defending what it sees as its core interests.
Under President Xi Jinping, the primacy of the Communist Party has trumped everything. Xi’s anti-corruption campaign, launched in his first term, has now been superseded by a crackdown on China’s private sector. No one has been spared, not even Big Tech bosses like Alibaba‘s Jack Ma, once feted as national champions to rival Silicon Valley’s finest.
Many of China’s superrich enjoyed intimate ties with Wall Street, often acting through “princelings,” the privileged offspring of the previous generation of Communist Party leaders. The humbling of the wealthy elite at the hands of Xi has sent a chill through America’s institutional investors in China. “We are now operating on the basis of a China discount,” said one top New York fund manager.
This discount does not appear – so far – to have deterred the powers that be in Beijing. Xi’s new campaign trumpeting “common prosperity” is viewed not just as a rallying call ahead of a crucial party congress endorsing his bid for a third term in power, but also as a necessary comeuppance for the tech titans and arrogant property developers like Evergrande, now teetering on the edge of bankruptcy, or Soho China, whose $3 billion sale to Blackstone was blocked by regulators.
In these circumstances, Wall Street’s options range from less than ideal to unpalatable. To pull out of China, as Microsoft’s LinkedIn did last month, would be a grievous act of self-harm. The financial stakes are simply much greater for the banks compared to U.S. tech companies, long squeezed by domestic rivals like Tencent and Baidu and by regulators determined to preserve the Great Firewall of China.
And while some counsel “selective decoupling” – hedging bets by moving capital and people from Hong Kong to, say, Singapore – the big U.S. banks and private equity giants know very well that this too would be badly received in mainland China.
The billion-dollar question, therefore, comes down to this: How far is Xi determined to pursue a reform agenda that puts at risk investor confidence and economic growth?
Xi’s defenders argue that this is a false choice – cracking down on private-sector excess and addressing economic inequality in China are two sides of the same coin. But such sophistry misses the point. A slowdown in economic growth is politically perilous; so too is an uncontrolled unwinding of debt-ridden Evergrande.
China’s trajectory to becoming an economic superpower depends on financial reform and an opening of its capital account to facilitate cross-border payments, the internationalization of the yuan and the growth of China’s middle class. In each case, American capital and know-how are indispensable.
In 2015-16, during the “minicrisis” in financial markets, authorities in Beijing realized that they had opened the capital account more quickly than warranted by the pace of reform. They will not wish to repeat the mistake, and observers like Barry Eichengreen, professor of economics and political science at the University of California, Berkeley, predict that the course of yuan internationalization will be “gradual and incremental.”
The smart money in New York is making a similar calculation, doubling down on China’s successful transition to modern superpower. It is a bold bet that will require strong stomachs in the coming months.
Source: Lionel Barber, NIKKEI Asia