China's schizophrenia - Week in Review #11 (Part 1)

This week’s review will have a slightly different format. I will quickly list out a few things that happened in the last two weeks with minimal analysis (Last week I skipped a weekly review for Noah Smith Part 2), and I will then try to connect the dots for you.

The reason for this format is that I find those events are really part of the same story, a story that can explain to a large extent many contradictory things investors and observers have about today’s China.

The Events

#1 A stream of capital market policies, but short of the rumored stabilization fund

The government has made some very impressive moves to stem the falling market, ranging from restrictions on short selling to Central Huijin’s statement on purchasing ETFs. I think the most notable one is by SASAC, the state assets regulator suggesting that for the first time ever, market capitalization will be taken into account in state-owned enterprise (SOE)’s KPI evaluation.

Last April, at Baiguan we discussed the significance of involving ROE, an investor-friendly metric into KPI evaluation, which could help boost the valuation of those enterprises. True enough, later in the year, the SOE sector, many of which have high dividend yields, has become one of the few bright spots in this super bearish market. Now, taking into account market capitalization into KPI will be an even more investor-friendly metric. It’s the most investor-friendly metric you can get. Effectively, what the regulator is saying now is that the socialist management of the SOEs will be partially judged on how well their capitalist investors see them.

However, despite these profound long-term structural reforms, the market has yet to see the trillion-yuan market stabilization fund as Bloomberg previously reported.

#2 The market kept on falling and falling before another reversal starting from Tuesday.

Perhaps because the rumored stabilization fund never seemed to materialize, both A share and Hong Kong stock markets kept falling after the brief comeback two weeks ago. On Monday another key psychological threshold of 2600 was to be breached in Shanghai and a disaster was brewing for smaller-cap companies. There was a genuine fear that the government was doing too little, too late.

On Tuesday, Feb 6 though, due to a combination of factors including the forceful measure to restrict short-selling, the Central Huijin statement, and also an unconfirmed report that Xi personally visited the securities regulator, the market started to surge back again. It seems Chinese retail investors can have a relatively happy Spring Festival holiday now. (Did Xi actually hear Bill Bishop’s comment that holiday time could be quite contagious for negative energy?)

Trading on Tuesday according to Bloomberg

#3 The US Embassy’s Weibo account became a “wailing wall” for China’s retail investors

Over last weekend, an army of retail investors flooded the comment section of the US Embassy’s Weibo account with their complaints about the stock market. Creating quite an embarrassment. They obviously had nowhere to go for making such comments because any “negative discussions” could be promptly deleted nowadays.

#4 A People’s Daily article triggered widespread ridicule

People’s Daily published an article in its newspaper titled “The Whole Country Is Filled with an Atmosphere of Optimism and Positive Energy整个国家都洋溢着乐观向上的氛围”. The app version of that article was shared widely by people on WeChat. For a moment my entire social media stream was filled with sharing of this article. This is a non-subtle way of sarcasm. It’s also really smart because it’s really hard for censors to do anything about it. You can’t really delete an article on People’s Daily extolling optimistic and positive energy, right?

This is how I shared this article on WeChat.

#5 Controversial ride-hailing ban and abrupt reversal at Pudong International Airport

Last week, in an event seemingly unrelated to the capital market, passengers at Pudong International Airport suddenly discovered they were not able to ask for ride-hailing services on popular apps such as Didi. Later it turned out that Shanghai transportation authorities invoked a 2016 regulation (which was never enforced before) that banned ride-hailing at the airport. Authorities cited concerns about income for taxi drivers who struggled to find customers despite waiting for a long time at the airport.

People were furious. Exacerbating the problem was the fact this was the busiest travel season of the whole year. Many journalists and commentators were publicly asking why, and some were even questioning whether corruption was behind this ban. The public outrage was so huge, that this ban only lasted for only 5 days. It may go down in history as the infamous “5-day Ban of Pudong”.

#6 Wu Qing, vice party boss of Shanghai, replaced Yi Huiman as the new head of CSRC

On Wednesday, Wu Qing 吴清 was appointed the new head of CSRC, the securities regulator, replacing Yi Huiman. I believe he is the first-ever CSRC head who actually had previous work experience in the securities industry. He started his career at CSRC and led the Shanghai Stock Exchange before becoming a deputy mayor and deputy party boss of Shanghai. None of his predecessors at CSRC have actual experience with securities. They came from a banking background: Yi Huiman (ICBC), Liu Shiyu (mostly PBoC), Xiao Gang (PBoC and Bank of China), Guo Shuqing (SAFE and CCB), Shang Fulin (PBoC), Zhou Xiaochuan (PBoC)…

The Questions

When you look at these events, what do you see?

For me, I see a pile of mess.

There are many baffling questions. Why the authorities can’t boost market confidence as quickly as possible? Instead, they are just taking baby steps and letting the market crash down right in front of their eyes. Why can’t they do something more dramatic? When they say the country is “full of optimism and positive energy”, do they really mean it, or have they also fooled themselves? What happened at Pudong? Why were they so dumb to outright ban a popular service for business travelers and holiday goers, adding more salt to the pain, for only 5 days before reversing the ban?

Is there really no way to make sense of it?

I think there is. In fact, there is a single story behind all of these. Understanding this story is a key to unlocking contemporary China. I have long wanted to talk about this story systematically. Past weeks’ events have offered me a chance.

The Story

Let me directly start with a key observation. Underpinning all these events is the division between two distinct parts of China.

One part is the well-to-do, educated, liberal, cosmopolitan, younger, critical, investor/capitalist China.

Another one is the low-income, traditional, less-educated, less-informed, unquestioning, small-town, and relatively older China.

At the risk of gross over-simplification, the “Liberalist China” are white-collar and gold-collar middle-class and upper-class people living in high-tier cities. They are well-informed about the way of life around the world and have middle-class+ lifestyles. They are not only conscious of their rights, but more crucially, they know how to articulate those rights.

They are different from the “liberals” in the US. One big difference is that they make up a much smaller percentage of the total population. I speculate they are only 10% (plus and minus 5%) of all Chinese people. So they are (only) around 80m - 200m. At the high end of this estimate, they are greater in number than any nation in Europe and even comparable to the size of the entire United States. But it’s only just 5%-15% of the population. If China were to have a general election, this population segment would not stand a single chance of winning.

Most members of the “Liberalist China” have stock trading accounts. According to government statistics, there are in total ~200 million stock accounts opened in China, with only ~50 million to be active right now. (You can see my population estimate of “Liberalist China” is roughly in line with this data.) So when people went to the “Wailing Wall” of the US Embassy complaining about stock markets, you should be aware that this only represents those ~50 million active retail investors, which is 4.2% of the total population.

The “Wailing Wall” also demonstrates another crucial aspect of “Liberalist China”: although they are decidedly a minority in this country, they are the most vocal, and therefore the most visible.

Most of the public discourses - articles, videos, discussions, content, culture - are created by the “Liberalist China”. This is also the part of China that Mr. Evan Osnos wrote about in his widely critiqued article China’s Age of Malaise. By definition, “Liberalist China” is what outsiders interact with (in >99% of cases) when dealing with China, simply because “Liberalist China” is more able to communicate externally. (Needless to say, the creator of this newsletter is also part of Liberalist China according to this definition.)

On the other hand, “Traditionalist China” makes the great, but silent majority. They are the least understood people by both foreign and domestic observers alike.

MJFinance’s Newsletter, my favorite Chinese-language substack by MJFinance wrote recently about this group, giving us a glimpse of who they are. Please pay attention to the numbers in this analysis: (translation and emphasis my own)

I'll ask you a question, which you probably can't answer: What is the median income in China, approximately in which-tier cities do people live, what is their lifestyle like, what is the family income and expenditure situation, and what are their expectations for the future?

The National Bureau of Statistics' 2023 data on residents' income and expenditure gives us some insights:

“In 2023, the median per capita disposable income of residents nationwide was 33,036 yuan (Robert: that’s ~$4,600, annual income), an increase of 5.3%, and the median was 84.2% of the average. Among them, the median per capita disposable income of urban residents was 47,122 yuan (~$6,600), an increase of 4.4%, and the median was 90.9% of the average; the median per capita disposable income of rural residents was 18,748 yuan (~$2,600), an increase of 5.7%, and the median was 86.4% of the average.”

Let's first talk about the urban resident. They earn around 47,000 yuan, which is less than 4,000 yuan per month. They spend over 24,000 yuan a year and can save around 20,000 yuan. In terms of expenditure, food and clothing account for 40%, housing for 23%, and medical care for 16%, with the remainder allocated to entertainment and other expenses. Where does this person live? Clearly not in a first-tier city, and they probably face some difficulties in second and third-tier cities. Roughly estimating, they are either a low-income earner in a second or third-tier city, or an average worker in a fourth or fifth-tier city. This is the median for urban residents in China.

Below them, there are hundreds of millions of people who cannot even reach this standard of living. They either have lower incomes and rely on low-income support, or they simply cannot spend that much in their actual lives. Would these people be frustrated by the continuous six-month decline of stock market? Perhaps they don't even have a stock account (the number of stock accounts in China is 220 million, and the actual number of people is estimated to be even fewer).

At Baiguan, we also talked about this when we discussed the reaction to a regulatory amendment regarding public security. At the time we used the word “core constituency基本盘”, which is the really same as my “Traditionalist China”:

… urban elites should be careful about what they wish for. If China were a 1-man-1-vote system, "you thought we would elect a Ronald Reagan, but in fact you will only get a Hugo Chavez", stoking and capitalizing on strong populist sentiments. Such is the reality in China and how the 基本盘(the “core constituency”) looks like.

Now comes a key observation from me:

A lot of things about China that seem contradictory, even ridiculous, stem from the fact that the authorities need to balance between a highly vocal minority (Liberalist China) and a silent majority (Traditionalist China).

To outsiders, only Liberalist China is the “real China”, because that’s the only visible part of China. The stock market, the US Embassy’s “Wailing Wall”, and Pudong International Airport - these venues are not where most people of Traditionalist China will ever visit.

Yet for China’s government, the “Traditionalist China” is a much bigger reality, simply because they make up the predominant majority of the population (~90%!) The intelligence-gathering apparatus feeds Zhongnanhai information about “Traditionalist China”, from every cell of the Party’s nervous system, all day long, which is an informational edge that no outsiders can match. The Party is also conscious that if this majority is not treated well, this majority will turn the country upside down. And the Party has every reason to be conscious of this reality. In the late 1940s, it was this same majority that helped communists topple the KMT government, which essentially represented another “Liberalist China” that was an even smaller percentage (less than 1%) of the total population.

Nowadays, whenever there are some incredulous developments in policy, many people like to question whether senior leadership has simply lost touch with reality. For them, I challenge you with this question: just name me 5 people in your social circles who earn the median income ($4,600 per year). Even I will struggle with this challenge. It turns out, maybe we are the ones who lose touch with reality. The information bubble we live in is simply incredible.

But, what “Liberalist China” lacks in size in terms of sheer number, it more than makes up in our loudness. We are eloquent, we are internationally connected, and what we speak about usually makes sense. So in terms of political significance, we are no less important than “Traditionalist China”, which makes this balancing act extremely difficult.

Let me give you a few examples.

When Shanghai, a quintessential “Liberalist China”, was locked down for months in 2022, it was a deeply unpopular policy for local Shanghainese. Civil disobedience of all forms was everywhere in the city. In hindsight, such a draconian and costly policy in the face of the highly contagious Omicron strain was also debatable. So if it were up to Shanghai's local government to decide without fear of national interests, they probably would have given up on this much earlier.

But why didn’t the government relent? Because the nature of the viral disease dictated that this would never be the choice of the Shanghai government. It had to be a national decision (Chairman Rabbit’s comment on this point). The rest of the country was mostly the territory of the “Traditionalist China” who genuinely had fears about Covid and whose medical resources were much worse than cities like Shanghai.

So essentially, the Shanghai lockdown of 2022 was about the “Liberalist China” sacrificing itself for the benefit of the mostly “Traditionalist China”. And since the “Liberalist China” is far louder than the “Traditionalist China”, the overall narrative about that event was very negative.

Then let’s think about Urumqi, the hinterland of “Traditionalist China”. In fact, Urumqi was locked down for much longer than Shanghai, for almost half a year. But nobody made much noise about it, only until a tragic deadly fire hit national headlines. Yet, even that fire did not trigger much action in Urumqi, but 4000 kilometers away, at the Urumqi Road in Shanghai it triggered unprecedented protests. The “Liberalist China” was finally done with it and used this occasion to make its loudest political statement yet. This time, the Party finally relented.

Now let’s come back to the People’s Daily article. Why can’t they anticipate the strong negative reaction to it? Please note one important detail about that article: it is not actually a WeChat article, but an article on People’s Daily’s newspaper and its own app that got shared on WeChat. This is an important distinction. The WeChat blog ecosystem is analogous to Substack, where more serious contents are discussed. It’s where the “Liberalist China” consumes content. What about People’s Daily’s own app? I personally don’t know anyone who uses that app. I also don’t know anyone outside the bureaucracy who subscribed to People’s Daily, the paper version. The implication of this is that this article is not intended for “Liberalist China” in the first place.

So who is the intended audience for this article? Bob Chen, an old friend of Baiguan, wrote the following observations on his WeChat Blog, which is another fantastic description of “Traditionalist China”:

I also reflected, is there really no audience for such articles? Perhaps, on the contrary, excluding the aforementioned group [Robert: basically the “Liberalist China”], with accurate targeting, there is still a large audience, and it can have a substantial morale-boosting effect for its core constituency.

First, those most receptive and most encouraged are those enjoying the dividends of the times. They are retired and their pensions are higher than the average wages of local young people. These people are treasures of the nation. Many of them are retired from the system and play a pivotal role in the stability of the entire society. They wholeheartedly approve of the dividends of the times and the bright future.

Second, as the former premier said, there are 600 million people whose monthly income is below a certain value. For them, although not all of them, this kind of propaganda has strategic significance. These people are at the lowest level of the economic trickle-down effect. Their income often comes from subsidies, transfer payments, government projects, or middle-class service outsourcing. They are currently facing difficulties, but they have a certain stability. One major reason is that their wage costs are extremely low, so most of them can still keep their jobs. Therefore, our country's unemployment rate is actually very low because there is great wage flexibility and a buffer of temporary jobs, not to mention the supportive role of government infrastructure projects.

However, they inevitably feel that economic prospects are worsening and people around them are becoming increasingly anxious. However, the headlines they read and the short videos they watch will not tell them these things. Furthermore, they are not involved in the stock market and do not have such a strong sense of it. Real-time reflection on such sensitive price indicators is not considered. Their expectations for the future and emotional stability are largely determined by the information they receive. At this time, it is very valuable for the media to play a positive tune, which can counterbalance the negative news they see. It also provides more breathing space for economic recovery and may even positively influence their marginal consumption tendencies.

[Robert: you may read about Bob’s other insights on China-US decoupling, and how to invest in China without China risk]

The nature of the Pudong Airport ride-hailing incident? Pudong International Airport is the “fortress” of “Liberalist China”. We were pissed that we couldn’t have the ride experience we always prefer at our own “fortress”, and we were very loud about it and even managed to create strong national and even international repercussions.

Now imagine the thinking process of the government in this case: what does the government stand to lose to placate this loud group and to preserve the international image of Shanghai? There may be some petty corrupt officials, but they are politically small potatoes. There are thousands of taxi drivers, but that’s as far as this can affect “Traditionalist China”, and those taxi drivers won’t have much of a voice for people to hear. Also, apart from them, no members of “Traditionalist China” will have anything to do with that damned airport. Okay, gotcha, cancel that stupid ban!

This is an easy political calculus for Shanghai’s government and a small win for “Liberalist China”, at the expense of a few thousand taxi drivers.

Let me cite Bob Chen again:

China has passed the golden age of reform and opening up, where the entire population worked together for common interests and enjoyed the dividends of the times. Every society faces the issue of conflicting interests, and every society has divisions. In sociology and political science, this is referred to as a "Cleavage", and there is a detailed set of research, a wealth of works and solutions.

Of course, I believe that our leaders have the wisdom to accommodate diverse voices. This is why the concept of the "Three Represents" was so refreshing at the time, as it had enough inclusiveness to incorporate emerging forces such as entrepreneurs into the entire theoretical system.

However, the current situation is more complex. Conflicts are easier to occur, and divisions are more apparent. The elderly and the young; the original inhabitants of the cities, those who have enjoyed the benefits of demolition, and those who have borne the burden of high housing prices in the later period; the inland “pink patriots小粉红” and the coastal foreign economic integrators, and so on.

Since the beginning of the COVID-19 lockdown, various divisions have already become apparent: Should we persist in protecting the elderly, or should we allow young people and producers to work?

Today, in the media front, we also face this issue. It is quite obvious that these 600 million people and the elderly, as well as the white-collar workers in cities, have a significant difference in their expectations of public media.

Happy pensioners vs disgruntled youth

So now let’s come back to the capital market.

Why it has taken so long before the government unleashed some really forceful measures to boost the market, like, buying stocks more aggressively, or, asking Xi to personally sound the clarion call?

This is because the Chinese government ultimately is responsible for the interests and welfare of its “median citizens” (I talked about this concept last time). Those median citizens only include some, but very few investors among them.

This is unlike the US, where the core of the population, the middle-class Americans have their life’s savings tied up in the capital markets in the forms of pension plans, mutual funds, stocks, and bonds. So anytime the capital market becomes shaky, the US government will go all-hands-on-deck mode, with the full weight of the Fed, the Treasury, and ultimately, the US Dollar behind.

Because our social structure is very different from the US, our government can’t be expected to respond similarly. A quick and easy fix? Not going to happen.

That is not to say the stock market is not important for China. It is very important. It’s just that frankly, at this stage, it is not the most important. It is not the No.1 priority. Besides the stock market, there are a lot more priorities on the plate, some of which are more important. For example, before splurging cash into the stock market, shouldn’t the government preserve enough dry powder to make sure the real estate sector touches down safely, or the local governments have enough funds to pay their employees? These matters have a much more direct impact on the welfare of the median citizens.

It is only when the stock market has become “worse than worst”, that more decisive action can be taken.

The Future

Until now, I have only tried to explain what has happened and why. However, what is more important is the marginal change in the future. After all, we base our actions not on what has happened, but on what we expect to happen.

I am afraid this post has gotten too long, so I will save this even more exciting topic for Part 2. Besides talking about the future, I can also apply this “Loud Liberalist, Silent Traditionalist” model to explain some key features of China, such as the censorship system.

I will start the Spring Festival holiday tomorrow, and the whole nation shouldn’t (hopefully) have many events, so there will be no weekly review for next week. But I think I have enough time to write about Part 2 during the holiday. Writing gives me joy. Do you want to read it sooner?

[Feb 16 note: Part 2 is out here]

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A moment of appreciation

The last year has been an incredible journey for me. I took a leap of faith and made a tough about-turn in my career from an investor/researcher type of person to become a CEO during a moment of crisis. Despite a very tough business environment (in fact, the toughest economic downturn my generation has ever seen), our business has stabilized and has gone back to growth, and both the fighting spirit and creative energy of our team have been stronger than ever.

Very importantly, we have found our voice. The company found a voice in the Baiguan project, which in less than a year has gathered close to an astonishing 4,000 subscribers. My teammate Amber also just found a new voice at Amber Sealed, talking about culture and creative ideas. As a talented pianist/programmer/currency trader/product manager/writer, this topic is dearest to Amber’s heart. And since last October, I have found my own voice here, with all of you patiently reading my work and engaging with me with your long, thoughtful comments and debates.

None of these can happen without your support and engagement. I extend to you my deepest thank you.

My little personal goal now is to reach 1,000 subscribers by the end of this month, and I am just a few hundred away from that goal. If you love my work and want more people to hear me, be sure to share it with your friends!

Finally, let me wish all of you a fruitful, wealthy, happy, Rock’n’Roll Year of Dragon!