China, the Digital Giant


A man looks at his phone near a giant image of the Chinese national flag

SHANGHAI – China has firmly established itself as a global leader in consumer-oriented digital technologies. It is the world’s largest e-commerce market, accounting for more than 40% of global transactions, and ranks among the top three countries for venture capital investment in autonomous vehicles, 3D printing, robotics, drones, and artificial intelligence (AI). One in three of the world’s unicorns (start-ups valued at more than $1 billion) is Chinese, and the country’s cloud providers hold the world record for computing efficiency. While China runs a trade deficit in services overall, it has lately been running a trade surplus in digital services of up to $15 billion per year.

Powering China’s impressive progress in the digital economy are Internet giants like Alibaba, Baidu, and Tencent, which are commercializing their services on a massive scale, and bringing new business models to the world. Together, these three companies have 500-900 million active monthly users in their respective sectors. Their rise has been facilitated by light – or, perhaps more accurate, late – regulation. For example, regulators put a cap on the value of online money transfers a full 11 years after Alipay introduced the service.

Now, these Internet firms are using their positions to invest in China’s digital ecosystem – and in the emerging cadre of tenacious entrepreneurs that increasingly define it. Alibaba, Baidu, and Tencent together fund 30% of China’s top start-ups, such as Didi Chuxing ($50 billion), Meituan-Dianping ($30 billion), and ($56 billion).

With the world’s largest domestic market and plentiful venture capital, China’s old “copy-cat” entrepreneurs have transformed themselves into innovation powerhouses. They fought like gladiators in the world’s most competitive market, learned to develop sophisticated business models (such as Taobao’s freemium model), and built impregnable moats to protect their businesses (for example, Meituan-Dianping created an end-to-end food app, including delivery).

As a result, the valuation of Chinese innovators is many times higher than that of their Western counterparts. Moreover, China leads the world in some sectors, from livestreaming (one example is, a lip-syncing and video-sharing app) to bicycle sharing (Mobike and Ofo exceed 50 million rides per day in China, and are now expanding abroad).

Most important, China is at the frontier of mobile payments, with more than 600 million Chinese mobile users able to conduct peer-to-peer transactions with nearly no fees. China’s mobile-payment infrastructure – which already handles far more transactions than the third-party mobile-payment market in the United States – will become a platform for many more innovations.

As Chinese firms become increasingly technically capable, the country’s market advantage is turning into a data advantage – critical to support the development of AI. The Chinese firm Face++ recently raised $460 million, the largest amount ever for an AI company. DJI (a $14 billion consumer drone company), iFlyTek (a $14 billion voice recognition company), and Hikvision (a $50 billion video-surveillance company) are the world’s most valuable firms in their respective domains.

Another important developing trend in China is “online merging with offline” (OMO) – a trend that, along with AI, Sinovation Ventures is betting on. The physical world becomes digitized, with companies detecting a person’s location, movements, and identity, and then transmitting the data so that it can help shape online experiences.

For example, OMO stores will be equipped with sensors that can identify customers and discern their likely behavior as seamlessly as e-commerce websites do now. Similarly, OMO language learning will combine native teachers lecturing remotely, local assistants keeping the atmosphere fun, autonomous software correcting pronunciation, and autonomous hardware grading homework and tests. With China in a position to rebuild its offline infrastructure, it can secure a leading position in OMO.

Yet, even as China leads the way in digitizing consumer industries, business adoption of digital technologies has lagged. This may be about to change. New McKinsey Global Institute research finds that three digital forces – disintermediation (cutting out the middle man), disaggregation (separating processes into component parts), and dematerialization (shifting from physical to electronic form) – could account for (or create) 10-45% of the industry revenue pool by 2030.

Those actors that successfully capitalize on this shift are likely to be large enough to influence the global digital landscape, inspiring digital entrepreneurs far beyond China’s borders. Value will shift from slow-moving incumbents to nimble digital attackers, armed with new business models, and from one part of the value chain to another. Large-scale creative destruction will root out inefficiencies and vault China to a new echelon of global competitiveness.

China’s government has grand plans for the country’s future as a digital world power. The State Council-led Mass Entrepreneurship and Innovation Program has resulted in more than 8,000 incubators and accelerators. The government’s Guiding Fund program has provided a total of $27.4 billion to venture capital and private equity investors – a passive investment, but with special redemption incentives. The authorities are now mobilizing resources to invest $180 billion in building China’s 5G mobile network over the next seven years, and are supporting the development of quantum technology.

The State Council has also issued guidelines for developing AI technologies, with the goal of making China a global AI innovation center by 2030. Xiongan, now under construction, may be the first “smart city” designed for autonomous vehicles. In Guangdong Province, the government has set an ambitious target of 80% automation by 2020.

Such aspirations will inevitably disrupt the labor market, beginning with routine white-collar jobs (such as customer service and telemarketing), followed by routine blue-collar jobs (such as assembly line work), and finally affecting some non-routine jobs (such as driving or even radiology). Recent MGI research found that in a rapid-automation scenario, some 82-102 million Chinese workers would need to switch jobs.

Retraining the displaced will be a major challenge for China’s government, as will preventing the major digital players from securing innovation-stifling monopolies. But the government’s readiness to embrace the emerging digital age, pursuing supportive policies and avoiding excessive regulation, has already placed the country at a significant advantage.

Kai-Fu Lee is a co-founder and CEO of Sinovation Ventures, a leading venture capital firm investing in China and North America.

Jonathan Woetzel is a McKinsey senior partner, a director of the McKinsey Global Institute, and co-author of No Ordinary Disruption: The Four Global Forces Breaking All the Trends.

Why Central Banks Continue to Put Asset Prices Out of Whack

A protracted exit from easy money will continue to create market puzzles

By Richard Barley

Even as the world’s central banks edge away from the extraordinary policies of the past decade, huge market distortions remain. The unwinding of years of easy money will continue to puzzle investors.

Take the euro, the dollar and U.S. and German government bonds. They are deeply linked: exchange rates often track expectations for monetary policy, which shows up in differences in yields between bond markets.

Difference between U.S. and German yields

How many dollars 1 euro buys

Normally, short-maturity bond yields, closely tied to central-bank actions, would really matter for currencies. But as central banks have sought to influence longer-term interest rates more directly, 10-year yields have gained in importance.

Even this isn’t straightforward, however. Earlier this year, the euro rose and the 10-year yield gap between the U.S. and Germany narrowed, as eurozone economic data proved strong and the European Central Bank signaled it would ease up on the monetary-policy pedal. Both moves could be interpreted as investors rethinking the relative prospects of the eurozone and the U.S.

The euro is still flying, up more than 12.5% against the dollar this year. But the U.S.-German bond spread has widened since September to more than 2 percentage points. The German 10-year yield, at 0.34%, just hasn’t reacted much to the brighter outlook.

Are either bonds or the currency mispriced? Perhaps not. The euro, for instance, might be better able to look at the endgame for monetary policy than current yield differentials. Bonds have still to contend with sizable purchases by the ECB, and forward guidance that rates will stay low for a long time yet.

A measure of future interest rates in the U.S. and Germany—the difference in five-year yields starting in five years’ time—tells a related story. This measure should be less affected by the impact of today’s influential forward guidance, and hence contain more information about where policy might be headed in the longer term. The U.S.-German gap on this measure has a closer fit with what the euro has been doing recently, data from ING shows.

Meanwhile, central-bank policy elsewhere, particularly in Japan, is in the mix. Since the Bank of Japan is holding yields down, Japanese investors need to look elsewhere for returns. But the cost to hedge against moves in the dollar has risen, making U.S. bonds less attractive, notes Lombard Street Research. European bonds may be benefiting from Japanese purchases, holding yields down but supporting the euro.

If markets are all about putting a price on the future, then right now, some markets seem more curious about what lies ahead than others.

Creeping Fascism, Part 5: “the world’s most sophisticated, high-tech systems to keep watch over citizens”

China’s Tech Giants Have a Second Job: Helping Beijing Spy on Its People  
(Wall Street Journal) – HANGZHOU, China—Alibaba Group’s sprawling campus has collegial workspaces, laid-back coffee bars and, on the landscaped grounds, a police outpost. 
Employees use the office to report suspected crimes to the police, according to people familiar with the operation. Police also use it to request data from Alibaba for their own investigations, these people said, tapping into the trove of information the tech giant collects through its e-commerce and financial-payment networks. 
In one case, the police wanted to find out who had posted content related to terrorism, said a former Alibaba employee. “They came to me and asked me for the user ID and information,” he recalled. He turned it over. 
The Chinese government is building one of the world’s most sophisticated, high-tech systems to keep watch over its citizens, including surveillance cameras, facial-recognition technology and vast computers systems that comb through terabytes of data. Central to its efforts are the country’s biggest technology companies, which are openly acting as the government’s eyes and ears in cyberspace. 
Companies including Alibaba Group Holding Ltd. , Tencent HoldingsLtd. and Baidu Inc., are required to help China’s government hunt down criminal suspects and silence political dissent. Their technology is also being used to create cities wired for surveillance. 
This assistance is far more extensive than the help Western companies extend to their governments, and the requests are almost impossible to challenge, a Wall Street Journal examination of Chinese practices shows. 
Going Mobile 
Unlike American companies, which often resist U.S. government requests for information, Chinese ones talk openly about working with authorities. Tencent Chief Executive Ma Huateng, also known as Pony Ma, and Alibaba founder Jack Ma both have voiced support for private companies working with the government on law enforcement and security issues. 
“The political and legal system of the future is inseparable from the internet, inseparable from big data,” Alibaba’s Mr. Ma told a Communist Party commission overseeing law enforcement last year. He said technology will soon make it possible to predict security threats. “Bad guys won’t even be able to walk into the square,” he said. 
In practice, China’s internet giants, which have benefited from trade policies shielding them from foreign competition, have little choice but to cooperate in a country where the Communist Party controls both the legal system and the right to function as a business. 
Tencent, the world’s largest online videogame company, dominates Chinese cyberspace with news, video-streaming operations and its WeChat app, used by nearly one billion people to communicate and for mobile payments.

Beijing activist Hu Jia said he bought a slingshot online after a friend recommended it for relieving stress. He paid with WeChat’s mobile-payment feature. Mr. Hu said he was later interrogated by a state security agent, who asked if he was planning to shoot out surveillance cameras near his apartment. 
A few years earlier, Mr. Hu said, he had messaged a friend headed to Taiwan with the names of activists he might want to see while traveling there. Later, he said, state security agents showed up at the friend’s house and warned him against meeting Mr. Hu’s acquaintances. 
“Experience has proven that WeChat is completely compromised,” especially for people on the government’s watch list, Mr. Hu said. “Everyone has a spy watching them. That spy is their smartphone.” 
This article goes on for another 1500 terrifying words. Read the rest here.

What’s happening in China is a merger of Big Tech and an already-existing police state, to produce a Big Brother right out of George Orwell’s Nineteen Eighty-Four.

The result is obviously chilling for anyone trying to change the status quo, along with anyone who has anything the government might want. Access to one’s online “secrets” gives the authorities leverage that not many can resist.

But that’s China, not the West, right? No chance of that happening here. Let’s hope.

But besides hoping, there are things we can do to keep tomorrow’s public/private surveillance partnership from knowing absolutely everything. First, we can take steps to shrink our online profile. Ex-hacker Kevin Mitnick’s The Art of Invisibility is a good place to start.

Second, we can move some of our finances out of the immediate reach of the NSA/IRS by owning physical precious metals, cryptocurrencies (though transacting with bitcoin et al will soon be visible to governments), and “internationalizing” via offshore real estate, insurance policies, bullion storage and second passports.

None of this is a complete, or even adequate, solution. That would require a return to constitutionally limited government with a Bill of Rights that functions in fact as well as spirit.

But it’s a start.

Pakistan’s Disunion Puts Investment at Risk

By Kamran Bokhari

Jihadism has been radiating out of Pakistan for decades and causing problems for the country’s relationships with other governments. Lately, however, it’s been Pakistan itself that is suffering from its homegrown Islamism. The country was founded on a contradiction between secularism and Islamism, and though it has covered up its incoherence, it has never overcome it. The contradiction is finally catching up to the country, and things in Pakistan will get worse before they get better.

Warning Signs

Evidence that things in Pakistan are reaching their boiling point came, paradoxically, from the outside. A Nov. 22 report by a Pakistani daily said that a Chinese delegation visiting Pakistan had expressed concerns that political instability could adversely affect the tens of billions of dollars that China was investing in the South Asian nation. The report said that on Nov. 21, a joint committee on the China-Pakistan Economic Corridor—part of China's One Belt, One Road initiative—approved the broad parameters of a long-term plan for the CPEC but failed to agree on development projects and financing for special economic zones. Speaking to reporters after the meeting, a Pakistani minister who serves as the country’s point man on the CPEC acknowledged that political unrest since 2014 was undermining the mega-development Project.

Pakistan has grown more unstable since the United States invaded neighboring Afghanistan after 9/11. In fact, over the past decade, Pakistan has been the target of a vicious jihadist insurgency that has claimed as many as 80,000 lives. Yet the Chinese still went ahead with the CPEC in 2013. Four years later, China, usually a stalwart ally, is beginning to second guess its investment plans for Pakistan.

Meanwhile, Pakistan's relations with its historical ally, the United States, have also hit an all-time low. The incoherence in Islamabad is preventing the country from working effectively with the US to address common concerns about the insurgency in Afghanistan. The top American commander in Afghanistan said Nov. 28 that he had not seen a change in Pakistani support for Afghan militants even though the administration of President Donald Trump has taken a tougher line against Islamabad. US Defense Secretary James Mattis is currently visiting the Pakistani capital, where he has said he will try “one more time” to work with Islamabad before taking “whatever steps are necessary” to address its alleged support for Afghan militants.

India, Pakistan's archrival, has expressed its own concerns about Islamist militants operating from Pakistan. In 2008, terrorists from Pakistan carried out one of the worst attacks in India’s history, killing 164 people and wounding over 300 more in Mumbai. Under intense pressure from India and the US, Pakistan vowed to crack down on Jamaat-ud-Dawah, the group responsible for the attack.

Almost a decade later, however, Jamaat-ud-Dawah is more entrenched than ever in Pakistan. It recently formed a political party, and its founder and leader, Hafiz Muhammad Saeed, was released from house arrest on Nov. 23. The United Nations Security Council designated Saeed a terrorist in December 2008, but his political movement has only gained ground in Pakistan, and Saeed himself recently announced his intention to run for public office in next year’s elections.

Finally, Pakistani relations with Iran have also been tense. Iran, which shares a border with Pakistan, has been the target of Islamist militancy emanating from sanctuaries in Pakistan’s southwest. Iran has warned Pakistan several times over the past few years that it will conduct raids across the border in Pakistan if Islamabad does not rein in anti-Iran groups on its soil. Already it has shelled groups across the border.

Political Decay

Pakistan has been incoherent since its inception in 1947. It has never settled the debate over whether it ought to be a secular or an Islamist state. Tensions have only gotten worse since the 2011 assassination of Punjab Gov. Salman Taseer at the hands of his own bodyguard. Taseer’s killer said the governor was guilty of blasphemy for criticizing laws prohibiting individuals from speaking out against religion. Many Pakistanis deemed the assassin a hero, and a team of lawyers enthusiastically defended him. It took the state five years to convict and execute him for the murder. The assassination and trial spawned an entire social movement and is now represented by a new political party, Tehreek-e-Labaik Pakistan.

In early November, Tehreek-e-Labaik Pakistan organized a sit-in at the capital to protest a perceived softening of the government’s stance on blasphemy. The army was finally called in on Nov. 26 to broker a deal, and in the end, the protesters got what they wanted. But even the military, which has ruled Pakistan intermittently for close to half of the country’s 70-year history and is still its strongest institution, can’t control what’s happening to the country.

Pakistan, moreover, used to boast a two-party political system that has since devolved into a patchwork of ideologically rigid groups, many of which are Islamist or otherwise right-wing.

One such party is Pakistan Tehrik-e-Insaf, led by cricketer-turned-politician Imran Khan. PTI is itself not an Islamist party, but its allies are Islamists. The party is likely to benefit in next year’s federal election from a major corruption scandal that has weakened the current ruling party, the Pakistan Muslim League, and forced its leader, Nawaz Sharif, to step down as prime minister. But whether Islamists or secularists control the government, the fight for Pakistan’s soul will not go away.

Neither will its economic struggles. Pakistan’s foreign exchange reserves hover around $14 billion, enough to cover only about three months’ worth of imports. Its reserves are falling because its exports are falling. Debt servicing stands at 29% of export earnings. Markets are speculating about a depreciation of the Pakistani rupee. And Pakistan’s population is exploding. It exceeded 200 million people this year, according to a 2017 census, and has increased by 57% since the last census nearly 20 years ago. At the same time, educational standards have been declining, with the literacy rate down to 58%. A third of the population lives in poverty.

For Pakistan to recover, it needs outside investment to fund things like the China-Pakistan Economic Corridor. But to secure such investment, the country must overcome the present situation, where multiple powerful factions have paralyzed the government.