The last few days have seen substantial losses in Chinese and Hong Kong equities. This is widely attributed to the surge in Covid-19 cases, which has triggered more lockdowns in Chinese cities and has highlighted the less-satisfactory performance of the Chinese vaccination programmes compared to the western ones.
These falls have also occurred against the background of serious talks between the US and China, with the US threatening Beijing with tough economic sanctions should it go too far helping Russia following its invasion of Ukraine. The US claims China is considering supplying weapons, which the US seeks to rule out. What President Trump started as a trade war has now become a bitter rivalry for world leadership.
Attention mainly centres on the hot war between Russia and Ukraine and the dreadful suffering that we witness daily. Meanwhile, the pattern of international politics is hardening around new economic-war tensions between the US led bloc of democracies and the Chinese-led coalition of authoritarian societies.
Alternative to the West
Countries that oppose the western rules-based order and democratic politics based on party choice and relatively free speech are having to huddle closer together to create an alternative economic system to the western-driven banks and markets. This matters for us all as individuals but also as investors.
There will be more friction in trade and investment between the two blocs. There will be competition for the support and trade of the more-independent emerging economies such as India and Pakistan. There will be threats to investment in countries that do not accept the western rules-based system. There will be moral concerns as environmental, social and governance (ESG) investment warns against some of the countries in which people might otherwise seek to invest.
As the governments and companies of the world scour the globe for additional and cheaper hydrocarbons, attention turns to Saudi Arabia.
In retrospect, the worries people had about governance and behaviour in Russia were good ones. Some investors denied themselves Russian investments because the standards of reporting, the conduct of some of the leading entrepreneurs and chairmen of the large enterprises, and the heavy interventions of the state put them off.
Others might say they sometimes made good money in the past by accepting these imperfections and taking advantage of the heavy discount on Russian shares and company valuations. Indeed, BP thought it had a good investment in Russian oil and hoped Russian conduct would improve. It has now written down more than $25bn of investment.
As the governments and companies of the world scour the globe for additional and cheaper hydrocarbons, attention turns to Saudi Arabia – one of the big three oil producers alongside Russia and the US. Is investment in this kingdom, which is fighting a war in Yemen and very dependent on-fossil fuel revenues, a suitable place for investors? Some will see more Saudi oil and gas as a short-term saviour of a world short of energy that is seeking to replace Russian supply. They will see that as a responsible investment. Others will dislike the Saudi approach to civil liberties and punishments and will worry about any source of hydrocarbon.
Other options to replace Russian oil and gas includes Iran, itself the subject of western sanctions for its conduct, and Venezuela, a state destroying its economy by very high inflation with a very controversial government.
The possibility of more Iranian oil coming available hinges on talks to restore the nuclear deal which are themselves delayed by issues over Russian trade with Iran. All too many of the world’s fossil fuels, and important minerals and metals from uranium to nickel rest in lands with autocratic systems of government. There is now a dash to find and exploit more of these important commodities in safer and more acceptable countries. In the meantime, compromises are made to keep the heating on and to build the batteries of the electrical revolution.
The rise of the Chinese dragon
The most difficult investment decisions surround China. China is the second-largest economy in the world and is on track to become the largest as it gradually raises the living standards of its massive population. China has outgrown the west by a huge margin in recent decades as it strives to get closer to western living standards from the poverty of the Mao era. It has a more enclosed domestic financial system and seeks a dual economy, where much is domestic and under communist party control, with a more liberated international trade sector.
It is difficult to judge if or when China will find Russia’s conduct sufficiently worrying to get them to apply more pressure to Moscow to settle.
China is now the main supporter of Russian leader Vladimir Putin in his war with Ukraine, though even China abstained rather than voting for Russia at the United Nations Security Council. The comprehensive joint Agreement of February 2022 between the two countries makes clear they are the central rival grouping in the world to the US-led western bloc. It is difficult to judge if or when China will find Russia’s conduct sufficiently worrying to get them to apply more pressure to Moscow to settle.
Critics of the Chinese system point to the treatment of the Muslim minority in the west of the country, to the clampdown on western-style freedoms in Hong Kong and Macao, and to the unyielding power of the communist party within the state.
Supporters of China think that engagement and allowing more access to western trade and investments will gradually, over time, smooth some of the authoritarian sharp edges and will enable the West and China to co-exist peacefully. As with all ESG investment issues, some wish to take a purist view and rule out investment in anything with moral problems, whilst others will invest in those who claim to be a on a journey to better conduct.
There will be big behind the scenes battles to appeal to the unaligned emerging market nations that have to date sought to stay friends and partners with both blocs. Two large democracies, India and Pakistan, have pursued this course. India has traditionally been hostile to China but friendly towards Russia – and will be concerned by the move of China and Russia into more joint action.
India has relied on Russian support over Kashmir and is concerned about the growth of friendly relations between Russia and Pakistan. Whilst it would seem sensible from the Western point of view for India to pivot more towards US and EU leadership this may not happen. India is very dependent on Russian arms and is now said to be buying cheaper Russian oil. Pakistan has traditionally been more oriented towards the US and the West, but its proximity to the Middle East and its conflicts has caused endless tensions in the relationship.
All this points to an acceleration in our investment theme of the partial retreat from globalisation, more intervention of states in markets, prices and supplies and a western pursuit of more friendly sources of energy and raw materials. Trade patterns will adjust, with an energy market and a banking market as well as different digital and military technology for each bloc. The China/Russia bloc will be at a discount for political risk and brings with it bad conduct.
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