Xi’s Big Mistake

I have mixed feelings about China. On the plus side, I think the country’s massive economic transformation may be one of the most impressive events in human history. Bringing hundreds of millions from primitive rural lives into relatively prosperous cities within a few years was awe-inspiring. I greatly admire the millions of Chinese entrepreneurs worldwide who create jobs and technology. They’ve helped the entire world in countless ways.

architectural photograph of lighted city sky


And yet, I can’t forget that China’s leaders are devoted, ideologically centralist communists. Americans sometimes apply that term casually to our political opponents. Xi Jinping is an actual communist. His regime permits some limited market-like activity, but only to help achieve the government’s goals, which remain communist.

When the West first began engaging with China in the 1980s and then allowed it into the World Trade Organization in 2001, many hoped exposure to our ways would tug China toward capitalism. It seemed to be happening for the first few decades, too. But the hope is fading.

In a 2015 letter (When China Stopped Acting Chinese), I said this:

Beijing’s stimulus efforts created the stock market bubble; now their unsuccessful efforts to keep it from bursting are shaking my confidence in their desire to allow market forces to play a greater role in the transition from a top-down society to a consumer-driven, bottom-up society.
Still, I’ve learned not to underestimate the Chinese leadership. They make mistakes but usually recognize them and change course quickly. We’ll see what they learn from their current misadventures in stimulus and their attempts at top-down control of an essentially uncontrollable market. If they don’t learn the right lessons, China will face an even harder lesson in the future.

Six years later, it looks like Chinese leaders didn’t learn the right lessons. Xi has been trying to balance economic freedom and authoritarian control and it’s not working like it used to.

Today we’ll review some recent events that illustrate where Xi went wrong. Then we’ll think about whether the Xi government can change course, whether it wants to… and whether it will survive.

Selling the Rope

Chinese ride-hailing company Didi Chuxing had its US initial “public offering” (I’ll explain those quote marks in a minute) last month, raising $4.4 billion. The shares plunged a few days later. Why? Widely called the “Uber of China,” Didi seems to have good prospects. The problems came from outside.

For one, the Chinese government decided to investigate whether Didi presented a “cybersecurity threat.” The company was ordered not to accept new users and its mobile apps were taken down from online app stores. But audits, or lack thereof, may be a bigger problem, and not just for Didi. My friend Mark Grant explains in one of his letters this week:

The core of the issue is that the Chinese government will no longer give US market regulators, any of the regulating bodies, the power to inspect the audits of Chinese companies listed on US exchanges. There are at least 248 Chinese companies, listed on three major US exchanges, with a total market capitalization of $2.1 trillion, according to the US-China Economic and Security Review Commission.

Earlier this year the Securities and Exchange Commission began rolling out rules threatening to delist foreign companies from American exchanges if they do not meet US auditing standards for three years. The Chinese response was that Chinese regulators will conduct the audit inspections and deliver their conclusions to the US Public Company Accounting Oversight Board. This was soundly rejected, as it should have been, by the SEC. (emphasis mine)

In the press, recently, there has been all kinds of talk about the Didi IPO fiasco and the effect on Chinese tech companies and on new Chinese listings. This is all fine, but it does not go nearly far enough. The issues are much, much bigger.

On the equity side, how can you invest in a Chinese company, any Chinese company, regardless of size, or theoretical revenues or profits, without audited financials? There will be no way to know if any of it is accurate and foreign assertations will have all of the reliability of a drop of water purportedly not dripping down the Great Wall, because of the Chinese sunlight. No one will have any reliable knowledge of what is actually going on. No one, in his right mind, would invest in any company, domiciled anywhere, on this basis.

Mark is right; investors shouldn’t throw money at companies based on financial statements that don’t have some kind of trusted third-party verification.

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William K. 2 months ago Member's comment

Keep in mind that China IS a Police State, as all communist countries must be in order to stay communist. And the police state has lots of power, And understand also that power corrupts, and absolute power corrupts absolutely. That is both unfortunate and totally true.

Worse yet, the Police State government does not make many mistakes, and those that it does make, it has the power to force on people anyway. And even worse, that Police State has the skill and resources to win the war even without bullets. Stealth and deceit are far less damaging to valuable infrastructure than bombs and bullets. The future will certainly be "interesting."

Rob Contano 2 months ago Member's comment

Why did we list $DIDI again since we are going to delist $BABA?