China may be last to open up, but doing so will be a key driver for markets in 2023

There is a tendency in the west to see China as an authoritarian monolith – in contrast to the supposedly highly accountable democratic west, albeit only those with the shortest of memories can look at the current protests against COVID-19 taking place in China and think them somehow unique. 

The reality is, of course, different, for while over the course of his first two terms Xi has certainly moved to consolidate more power to the centre, the reality is still that, in the words of the old Chinese proverb, “The mountains are high and the Emperor is far away”, ie the relative autonomy of the regions remains strong and thus the COVID restrictions – and by extension, the protests – reflect a tapestry of different regional interpretations of central government policies. 

Right now, it seems that the centre is asking the regions to ease back on COVID restrictions, which is why, despite the headlines, the markets believe this is more about opening up than closing down again.

A useful way to think of China is as being like Europe and the EU - a set of regional economies with a high degree of autonomy but with a centralised controlling permanent bureaucracy that nevertheless has its own internal politics and factions. 

Geographically, it is also about the same size as Europe and the variation in climate as well as language/dialect puts Harbin in the north at the equivalent of Norway while Hong Kong is down at Gibraltar.

All this is to say that we need to be careful what narrative we are following and in whose interest it is for us to believe it. Obviously, the US clearly sees China as its new great rival, and thus the dominant US-driven western narrative is going to be negative from now on, but as investors, we need to make our own assessment and watch what China is doing rather than rely on the predictions of others. 

In this context, it is worth remembering that China has a tendency to ‘test’ new policies on certain regions before going ‘nationwide’ with them. Thus, it is entirely possible for, say, the Greater Bay Region, including Hong Kong, to see an earlier easing of Covid restrictions than other parts of the country. Indeed, watching the recent spike in the prices of Macau casino stocks, the locals are clearly looking at things this way. This is also important in the context of, yet another, US hedge fund-driven discussion about the likelihood of the Hong Kong peg breaking, a trade likely to prove as fruitless as the last few attempts have been. 

While China is undoubtedly moving away from using the $ for anything other than direct trade with the US, the most likely direction of travel would be to simply peg the HK$ against a trade-weighted basket, similar to the informal approach used currently to manage the Rmb itself. This would enable the Chinese currency itself to remain only semi-convertible while allowing Hong Kong to resume its previous role as ‘the interconnector between the rest of the economy and the rest of the world'.

The steady re-opening of China is thus, in our view, one of the main themes for 2023 and while many are understandably concerned at some of the images coming out of China, we believe that the direction from the central government is for less rather than more. 

Perhaps ironically, investors concerned over inflation should probably be thankful that the central government delayed re-opening as long as it did, for if China had re-emerged as quickly as the west did and at the same time, into a world of shattered supply chains and inventory bottlenecks, then the impact on commodity prices would have been dramatically worse. As it is, the steady opening up next year is still likely to be a positive tailwind for industrial metals and other commodities.