The fight over the Fed

The new Powell doctrine

The Fed has taken a bold gamble under Jerome Powell. Will he get to see it through?



No one can accuse him of inconsistency. 

Over the past year Jerome Powell, chairman of the Federal Reserve, has again and again used the same phrasing to kick off his press conferences after it sets interest rates. 

“Good afternoon. 

At the Federal Reserve, we are strongly committed to achieving the monetary-policy goals that Congress has given us: maximum employment and price stability.” 

It may not set pulses racing. 

But that is just how Mr Powell wants it: a projection of control, in terms any schoolchild can understand.

The simple wording belies a remarkable evolution in Fed policy and practice on his watch. 

Mr Powell has overseen a giant monetary response to the covid-induced slowdown. 

The Fed has bought more than $4trn in assets during the pandemic (equivalent to 18% of gdp), dwarfing the scale of its actions after the global financial crisis, and swelling its total balance-sheet to $8.3trn (see chart 1). 

Mr Powell has refined the way the Fed communicates, targeting his messages at ordinary Americans rather than economists. 

He has led a landmark shift in the way it thinks about interest rates. 

And in the process, he has presided over a bold gamble, keeping policy ultra-loose even as inflation soars. 

To his supporters—of whom there are many—he saved America from an economic catastrophe. 

To his critics, however, he is steering it into danger.

These days much of the conversation about Mr Powell focuses on whether President Joe Biden will reappoint him. 

His four-year term as chairman ends in February 2022. 

Mr Biden is expected to announce in the coming weeks whether he will renew Mr Powell’s term or nominate a replacement, giving markets time to brace for the change, if there is one. 

Progressives within the Democratic Party accuse Mr Powell of slowly dismantling rules intended to make the financial system safer, and would prefer a chairperson who is tougher on banks. 

Lael Brainard, the lone Fed governor who has consistently opposed moves to, for instance, soften lenders’ leverage limits, is their favoured candidate.



Still, most Fed watchers expect Mr Powell to get a second term. 

Betting markets assign it an 85% probability. 

Most Democrats and Republicans think he has done a good job in tough times. 

The economy is recovering and stocks are near all-time highs. 

Why rock the boat? 

The politics would look good, too. 

Mr Biden would re-establish a precedent, broken by President Donald Trump, of reappointing Fed chiefs first chosen by a president from another party. 

It would also make sense to anyone tracing the arc of Mr Powell’s leadership. 

Over the past four years he placed his big bets. 

The test of whether he was right or rash will come in the next four.

An assessment of Mr Powell’s record can be divided into three periods. 

The first was before the pandemic. 

His most notable achievement was arguably political. 

The central bank faced the gravest challenge to its independence in decades when Mr Trump railed against its interest-rate rises. 

Mr Powell stuck to the Fed’s agenda and patiently explained that the president had no authority to fire him, but otherwise refused to get drawn into a war of words. 

Mr Powell also displayed intellectual flexibility. 

When inflation dipped in 2019, the central bank swiftly reversed gear and began cutting interest rates—and held them low even as unemployment declined to levels that economists had assumed might lead to upward price pressures. 

“He let the economy push farther and farther than anyone thought it could go,” says Jason Furman, an economic adviser to President Barack Obama.

The second period came with the onset of the pandemic. 

As the economy came to a sudden stop in March 2020, stocks plunged and credit markets seized up. 

Mr Powell wasted no time in engineering a massive rescue, slashing rates to zero and buying up a wide range of assets—not just Treasuries and mortgage-backed securities but also, for the first time, corporate bonds. 

Within three months the Fed’s asset holdings had increased by $3trn.

The third period of Mr Powell’s tenure, unfolding now, is the most contentious. 

Many who applauded the Fed’s stimulus during the depths of the pandemic think the central bank should have started rolling it back. 

Monthly asset purchases of $120bn make little sense, and indeed may be storing up trouble, when inflation is running above 5%. 

Move too slowly to unwind, and financial markets could overheat (some prominent investors such as Jeremy Grantham argue that they are already red-hot). 

Move too quickly, and a market crash would be a self-fulfilling prophecy, rippling through the global economy. 

Sonal Desai of Franklin Templeton, an asset manager, calls it the “hardest high-wire balancing act we’ve seen in a long time”.

Priced to perfection?

Mr Powell is trying to pull it off by giving markets plenty of warning, in the hope of avoiding a repeat of the “taper tantrum” that spooked markets in 2013. 

He is due to speak at an annual Fed jamboree—usually held in Jackson Hole, Wyoming, but being conducted online because of covid-19—on August 27th, after The Economist goes to press, when he is expected to say that a tapering of asset purchases could start later in the year. 

Many observers expect a three-step shift: a pre-announcement at the central bank’s rate-setting meeting in September that a tapering announcement will come at its November meeting, followed in December by actual tapering.

Guesses about the tapering schedule, though, are only one element of the debate now swirling around Mr Powell’s agenda. 

Last year he introduced a new framework for monetary policy (building on a shift that started under his predecessors, Janet Yellen and Ben Bernanke), announcing that the Fed would target an average of 2% inflation over the longer run, while also seeking to let the economy reach full employment. 

He has also pledged that the Fed will not raise rates until inflation is at 2% and is forecast to stay above it for some time. 

Tapering can begin earlier, as long as there is “substantial further progress”—a deliberately vague phrase—towards meeting the inflation and employment targets. 

What he could not have foreseen was the extremely uneven recovery from the pandemic, with prices climbing but the unemployment rate still nearly two percentage points higher than at the start of 2020.

“The Fed has tied its hands to be quite late to remove monetary-policy accommodation,” says William Dudley, former president of the New York Fed. 

Mr Dudley thinks that the Fed’s new framework is correct, but worries that the implementation has been too rigid. 

He says that he would have argued for less extreme conditions to taper or to raise interest rates. 

Mr Furman warns that Mr Powell could be paving the way for unpredictable policy, which would give rise to the very market shocks he has wanted to avoid. 

“There’s been a bit of assuming that everything’s going to work out exactly right, and not having much public communication about what will happen if it doesn’t,” he says.

Yet many other economists and Fed veterans support Mr Powell’s approach. 

The average-inflation framework was designed with the broader backdrop in mind: steadily lower inflation was keeping interest rates low and limiting the Fed’s monetary space. 

Covid-19, though an extreme challenge, is unlikely to alter these long-standing structural forces. 

Much of the recent surge in inflation appears to stem from ephemeral factors such as gummed-up supply chains. 

David Wilcox, a former research director at the Fed, says that as long as inflation expectations remain anchored at 2%, the Fed is likely to wait it out. 

“In that context an abrupt move to tighten could be a costly mistake,” he argues.

If inflation persists and filters into wages a year or so from now, that would be a different story—but a modest overshoot would not necessarily be an unwelcome one. 

“If inflation runs to the upside, that’s a problem they want to have, and they have the tools for dealing with it,” says Alan Levenson of T. Rowe Price, an asset manager. 

As it stands, the central forecast of members of the Fed’s rate-setting committee is for inflation to return to roughly 2% next year. 

Market pricing of Treasury bonds points to much the same outcome.



For all the controversy about Mr Powell’s monetary policy, it is his approach to financial regulation that has been the biggest lightning-rod for his political opponents, especially progressive Democrats. 

“I see one move after another to weaken regulation over Wall Street banks,” Senator Elizabeth Warren said at hearings in July. 

Defenders of Mr Powell say that such a characterisation is unfair. 

The Fed did, for instance, scrap pandemic-era limits on most banks’ stock buybacks and dividend payments at the end of June, but that was only after subjecting them to three stress tests to confirm that they had more than enough capital. 

In other areas, the Fed under Mr Powell has been strict. 

In March it rebuffed banks’ requests to extend an exemption on leverage caps that had helped them during last year’s slowdown.

If Mr Biden wants to keep Mr Powell in his job while signalling a tougher stance on regulation, he has an obvious solution. 

Randal Quarles’s term as the Fed’s vice-chairman responsible for banking supervision ends in October (see chart 2). 

Instead of nominating Ms Brainard as chairwoman, he could choose her to replace Mr Quarles. 

For markets, such a reshuffle would minimise the turbulence from changing Fed chiefs at a critical juncture. 

Politically, it would be deft. 

And it would give Mr Powell a chance to answer the fundamental question posed by his policies: whether the great monetary loosening, so necessary last year, can be unwound without doing great harm to the economy. 

Automatic for the people

China’s future economic potential hinges on its productivity

Can the government boost it?


Noblelift, based in Changxing, a town on the banks of Tai Lake, provides robotic tools for warehouse management: self-driving pallet jacks and sorting systems that make picking and fetching quicker and less dependent on humans. 

The factories in which it builds its wares are themselves a blur of robot arms. 

“There’s no comparison with the way things used to be,” says Ding Yi, Noblelift’s founder. 

The company’s main factory has only 350 workers. 

He says that in the old days it would have needed nearly four times as many.

In 2010 China was home to fewer than 50,000 industrial robots. 

Today it has 800,000—nearly one in three of the robots in the world. 

This is in part because robots are cheaper than they used to be, and more capable. 

But it is also because, as China has grown wealthier and older, wages have increased a lot.

Factory workers who earned about 8,000 yuan a year in 2000 ($1,000, at the time) may now make almost ten times that. 

For bosses like Mr Yi that has dramatically tipped the balance in favour of automation (see chart 1). 

Almost overnight, Chinese industry has gone from being labour-intensive to robot-intensive.


Companies are always in pursuit of such ways to increase productivity. 

Countries in search of economic growth like them, too. Xi Jinping, China’s president, has made productivity a priority.

In some respects, the ambitions of Mr Yi and Mr Xi seem well aligned. 

But many observers believe that Mr Xi is relying too little on the market forces which have shaped Mr Yi’s investments and too much on state power. 

As a result he risks steering the country away from the high-productivity future he wants to bring about. 

The shape of tomorrow’s global economy hangs on whether those critics are right or whether, armed with numerous detailed plans and burdened with glorious purpose, China’s leaders can achieve their goal.

Economic growth depends on just three basic factors: how many people are working; how much capital they have at their disposal; and how productive they are. 

China’s turbocharged growth over the past four decades was the result of all three factors coming together at full pelt.

The urban workforce soared from 100m in 1980 to about 500m today. 

The increase in the capital stock was even more dramatic. 

In 1980 China had fewer than 15,000 kilometres of modern road; today it has more than 700,000km, not to mention high-speed trains, too many airports to shake a stick at, power grids and all the other accoutrements of industry. 

And at the same time China experienced a productivity boom thanks, in large part, to the steady dismantlement of central planning. 

Competition shook up the economy. 

Businesses became better run and workers went wherever wages were highest.

From 1980 to 2010 China’s annual gdp growth averaged 10%. 

In the past decade, though, things slowed down. 

The central bank now thinks potential growth is about 5.5% a year. 

The working-age population is no longer expanding; the latest national census, published in May, revealed a total population on the brink of decline. 

The appetite for infrastructure is increasingly sated, if not glutted; spending on the built environment has reached the per-person levels of much wealthier countries.

That leaves productivity paramount. 

But the improvements which came from loosened state control have not been maintained. 

The World Bank calculates that, since 2008, China’s total-factor productivity (tfp)—the amount of gdp growth that cannot be explained by capital or labour—has grown by just 1.1% per year, less than a third the rate of the previous three decades. 

That is still double the level in America over the same decade. 

But the relevant comparator for Mr Xi and his colleagues is China’s recent past.

Some of this slowdown simply reflects the move from catch-up to caught-up. 

Developed countries have lower potential productivity growth. 

But many analysts also think that China’s economic model is particularly wasteful, a failing evidenced by its surging debts. 

Nowadays it adds about four yuan of new debt for every additional yuan of gdp; a decade ago it needed just two yuan of debt to get the same result.

Speed it up a notch

It was in 2017 that Mr Xi, better known for quoting Mao and Marx, started to talk of tfp and the need to increase it. 

In March last year, just as China emerged from its covid-19 lockdown, the central committee of the Communist Party and the State Council released a 32-point vision for boosting productivity. 

In the five-year plan for the economy which was finalised this March, the government specified that it wants labour productivity to grow quicker than gdp.

If there is to be real progress, it will be driven by companies and individuals, not top-down diktats. 

But the state’s moves are shaping the landscape in which those processes will play out. 

With all due respect to the government’s 32 points, it is possible to batch them into three broad categories: industrial modernisation; further urbanisation along new lines; and what might be called catch-up reforms.

The first element, as Noblelift illustrates, is the upgrading of industry. 


For companies the calculations are simple: modernising their factories stops them from becoming uncompetitive. The government, though, has two grander goals.

The one which has received most attention outside China is a perceived geopolitical imperative. 

Faced with rising American enmity, China wants to cultivate greater self-reliance in making essential products from semiconductors to agricultural machinery. 

That goal, encapsulated in the “Made in China 2025” policy, requires improving its factories, raising its ambitions and conquering new industries.

The other goal reflects economic philosophy. 

China believes that sustaining high productivity depends on retaining a large manufacturing base. 

Schooled in Marxist doctrine, China’s leaders have long regarded industry as more economically valuable and more strategically useful than services. 

Whether the services in question consist of waiting tables or creating financial derivatives hardly matters.

That is a debatable proposition: service-sector work can be highly productive. 

Nevertheless, the government has cemented it as policy. 

It will fight to prevent a decline in manufacturing’s share of gdp, which at about 25% is higher than that of Germany or Japan, the industrial heavyweights of the rich world.

Plans to achieve this go well beyond automating assembly lines. 

The government is giving companies advice and subsidies to get information technology deeply embedded into all their operations. 

Local developers are designing software tailored to helping them manage their processes more efficiently.

Until a few years ago factory bosses regularly kept track of inventories and orders on paper, says Zhou Yuxiang, founder of Black Lake, one such developer. 

The desktop-based systems of sap and Oracle never translated well to China. 

Now, manufacturers are using applications on their mobile phones, letting them collect, analyse and act on data in real time. 

“They are becoming the most flexible companies in the world,” he says. 

The country hopes that it can enjoy a late-starter advantage in digitising industry, in the same way that it leapfrogged from being a cash-dominated economy to being the world leader in mobile payments.

The second part of the productivity push is better urbanisation: bigger agglomerations to which workers have better access. 

China has capped the size of its biggest cities, fearful that they might become unmanageable. 

At the same time, it knows that bigger urban agglomerations, which allow for specialised labour and interwoven supply chains, tend to be more productive. 

So it is developing giant city clusters in which big hubs are linked to smaller satellites. 

The idea is to generate the benefits of agglomeration without horrifically congested traffic, overburdened schools and other very-big-city blues.


China has approved plans for 11 mega-clusters in all (see map). 

The average population of the five biggest is about 110m, nearly three times bigger than the 40m in Greater Tokyo, the world’s biggest existing cluster. 

Having discussed the idea for several years the government is beginning to invest in making it real. 

Over the next three years it has committed to double the length of intercity commuter rail lines.

Even deep in China’s interior, cityscapes are changing. 

In the west, Xi’an, the capital of Shaanxi province, has been fused to Xianyang, a separate city 30km away, creating a metropolitan area with 15m residents. 

An hour’s drive north of the cities fields of grain have been replaced by logistics zones and industrial parks. 

“This place used to be far out of the way. 

No one would come here,” says Ma Yu, a middle-aged migrant from the countryside. 

Now a bullet train carries her to Xi’an in 13 minutes.

The ladder starts to clatter

As well as joining cities together, it is also blanketing them in 5g mobile networks, planting sensors galore in their highways and sewers to monitor performance, and studding their lampposts with surveillance cameras. 

The party believes all this will allow the distributed mega-cities to be managed with a precision and efficiency which makes them paragons of hyper-productive modernity. 

This may betray a lack of insight into what it is that really makes cities hives of innovative oomph.

Making the most of what cities offer also requires reform of the hukou, or residency permit, system which makes most migrants second-class citizens in the cities where they work. 

Without a local hukou they cannot collect unemployment insurance, and their children struggle to get into local schools.

Along with being profoundly unfair, discriminating against some 200m citizens this way is also costly. 

When workers hit their 40s and worry about access to health care and pensions, they tend to go back to their natal towns.

In doing so they willingly opt for lower-paid, lower-productivity jobs, says Cai Fang, an adviser to the central bank. 

The government has talked about hukou reform for years and done little. 

Recently, though, it has actually eased the pathway to hukou in most cities (just not its very biggest). 

It has also made social benefits more portable within the urban mega-clusters.

The last of the three categories of productivity enhancement is what might be termed catch-up reform: a series of changes to bring the country closer to the standards of richer countries, albeit in a dramatically different political context. 

The higher-education system is testament to the potential gains. 

It is easy to point to problems that still bedevil China’s schools, from too much emphasis on test preparation to too little investment in rural students. 

Yet the increasing number of university graduates—46m in 2000, 218m this year—is a good proxy for large, continuous improvements in workers’ skills.


Another critical area of reform is allowing failure. 

One of the main ways to ensure that capital is allocated well is to let bad firms go bust; Mr Cai has cited evidence that firms going under drives as much as 50% of productivity growth in rich countries. 

In corporate China this form of creative destruction has often been suppressed. Over the past few years, though, bankruptcies have soared.

The courts accepted nearly 30,000 insolvency applications in 2020, a record (see chart 2). 

Investors are currently fixated on the saga of whether regulators will let Evergrande, the country’s biggest property developer, go bust—something which would previously have been unthinkable. 

And state-owned firms accounted for roughly half of last year’s bond defaults, giving the lie to expectations that the government would always save them.

Trying to keep up with you

Better education and more bankruptcies are just a couple of the paths forward. 

The 32-point productivity plan vows to make it easier for companies to issue bonds in the first place, to co-operate more with other countries on scientific research, to better protect intellectual property, and on and on. 

The plan received little attention at the time; many observers have grown tired of such promises by China. 

Yet the fact that there is still so much unfinished business, and that the government acknowledges this, may signal that such cynicism is being overdone, at least a bit.

Will China’s productivity policies actually work? 

History offers little by way of precedent. 

Autocracies have become successful industrial nations before, if never on such a huge scale. 

But it is not obvious that they can move beyond that. 

China is currently at roughly the same income level that its two closest Asian forerunners, South Korea and Taiwan, were when they became democratic and strengthened their independent legal institutions—a transition which, in retrospect, seems to have been essential for governing their increasingly complex economies.

In China the party will remain the law. 

And the way that Mr Xi is using that power is making investors increasingly pessimistic. 

The government’s crackdown on tech darlings, from Ant, a fintech dynamo, to Tencent, a social-media giant, has served up a reminder of just how capricious its regulations can be.

Chinese officials say they are limiting the power of big tech platforms in order to to make the economy more competitive and thus more productive. 

Few investors buy that. 

Instead, the realisation has seeped in that Mr Xi’s references to communist ideology are, at some level, sincere. 

He appears to be uncomfortable with business leaders getting too rich. 

And he has made it his mission to reinforce the party’s grip on power. 

When he says “Government, the military, society and schools, north, south, east and west—the party leads them all,” he means it. 

This is not a basis for improving productivity you will find in many economic textbooks.

Deepening distrust between China and much of the world is another problem. 

Plugging itself into the global trading system did not boost Chinese growth just by opening up new export markets. 

International competition pushed its companies to be more efficient; access to cutting-edge technology allowed them to become more sophisticated. 

Now countries from Israel to the Netherlands are subjecting Chinese investments to closer review and limiting exports of some key inputs. 

A lengthening list of companies have chosen to scrap acquisition plans in America because they would have been impossible to complete.


Officials have come to believe that industrial policy of the “Made in China 2025” sort is, to an increasing extent, the only option available for some types of technological improvement. 

Li Daokui, a former adviser to the central bank, is confident that it will eventually succeed: “We are not the Soviet Union. 

We have the world’s largest contingent of young engineers. 

If pushed, we will develop our own technology.” 

Perhaps. 

But it will be expensive, both in terms of the direct cost and other spending priorities forgone.

Less funding for pension systems, for example, will hold back consumption, thus holding back investment and productivity in the services sector. 

According to s&p, a credit-rating agency, a full-bore pursuit of self-reliance could lop as much as one-third off China’s growth this decade. But Mr Xi is unlikely to be swayed. 

He seems to believe that truly ambitious technology investment, though it may often fail, offers the possibility of world-beating breakthroughs that will bring his country both power and productivity.

The biggest reason to believe that things might turn out better for China’s economy than these trends would suggest is that it has consistently shown an ability to correct mistakes. 

In the 1990s the government cut down bloated state-owned firms. 

Over the past five years it went from dismissing concerns about its debts to launching a deleveraging campaign, though those efforts are far from complete. 

“Leaders are willing to change when the pressure is there,” says Liu Shengjun of the China Financial Reform Institute. 

That they have become obsessed with how to boost productivity is a good starting-point. 

Achieving their aim, though, will take much more than robots—and maybe more change than they can stomach.

Investors Are Running Scared From China’s Stocks. Where to Find Opportunities.

By Reshma Kapadia

Illustration by Justin Metz


It has been a rough year for investors in China, especially those who forgot that it’s still a Communist nation with a government that can act unilaterally and change direction swiftly and ruthlessly. 

After some surprising, and very anticapitalist, moves in the past several months, Chinese stocks are plummeting. 

China’s market is down 20% in the past six months, while some of its biggest names have dropped more than 40%. 

Has China become uninvestible? 

No—but it has gotten a lot more complicated.

U.S. investors have largely focused on China’s tech giants, but given the situation today, there are better options. 

For years, the Chinese government allowed—even assisted—internet companies, enabling them to blossom with little intervention. 

This created lucrative returns for investors and helped the nation mint more billionaires—257—last year than any other country. 

Investors became less wary, even complacent, as the world’s second-largest economy seemed to be embracing capitalism.

That narrative has been unraveling. 

As President Xi Jinping makes an expected bid for a third term next year, he is trying to strengthen his grip on the Communist Party and address public discontent. 

That has led to a policy shift toward “common prosperity,” emphasizing social welfare and national security, and regulation that targets swaths of the economy, including the technology, education, property, and healthcare industries, and many of China’s most well-known and successful companies.



Illustration by Justin Metz


The moves have not been small: The Chinese government blocked the highly anticipated public offering of Alibaba Group Holding (ticker: BABA) affiliate Ant Group last fall, overhauled the fintech’s business model, and dealt a public rebuke to outspoken founder Jack Ma. 

Beijing also targeted soaring education costs by turning after-school tutoring firms into nonprofits. 

And it cooled a hot initial-public-offering market with an inquiry into the data practices of DiDi Global (DIDI) just days after it went ahead with its U.S. market debut—and chilled it further on Friday with plans to ban user data-heavy companies from seeking IPOs in the U.S., according to The Wall Street Journal. 

All served as a stark reminder of who is ultimately in control in China, and the risks to investors.

The pace, breadth, and uncoordinated nature of the measures coming from various regulators have been jarring, causing China enthusiasts like Stephen Roach, former chairman of Morgan Stanley Asia and a senior fellow at Yale University, to reassess his favorable view on China. “I stuck with it because fundamentals are impressive and strong,” he says. “This is a warning shot on that view.” His main concern: New regulations and increased scrutiny could stifle the “animal spirits” needed to help fuel innovation and keep China’s economy growing.


Investors are running scared. The KraneShares CSI China Internet exchange-traded fund (KWEB) has lost 45% in the past six months, with Alibaba down 30% and education companies like New Oriental Education & Technology (EDU) and Tal Education (TAL) down about 90% in the same period. In the first two weeks of August alone, investors yanked $3 billion out of China, according to EPFR Global.


Investors should be greedy when others are fearful, according to a Warren Buffett adage, and there is a lot of fear reflected in Chinese stock prices, even as some intrepid investors have gone back in. 

China is a $15 trillion economy, home to 1.4 billion people and myriad innovative companies—long-term investors cannot ignore it. But they shouldn’t ignore the multitude of risks, either.

So what’s an investor to do? 

First, understand the risks. 

Then, there are two ways to approach investing in China today—smaller companies, best owned through a mutual fund, and knowing when to go into some of the nation’s biggest names.

Illustration by Justin Metz


The Risks: What to Watch

When the two most powerful economies clash, the risks are plentiful. 

Let’s take the U.S. first: There’s bipartisan support for a tougher stance against human-rights abuses, and a broader desire for increased scrutiny of Chinese companies listed as American depositary receipts, or ADRs. 

The Securities and Exchange Commission is looking at ways to take steps that pave the way for delisting Chinese companies that don’t comply with U.S. auditing standards. 

SEC Chairman Gary Gensler has warned that many U.S. investors aren’t aware of the risks embedded in Chinese ADRs. 

This is because of a complex corporate structure called a variable interest entity, or VIE, that’s used to skirt China’s foreign ownership rules and results in U.S. investors owning shares in a shell company with a contract with the Chinese business operators. 

Even professional money managers have increasingly dumped Chinese ADRs in exchange for shares listed in Hong Kong; large-cap funds have half the exposure to Chinese ADRs today that they did two years ago, according to Bank of America.


Then there’s China. 

There are the “all bets are off”–type risks, like a conflict with Taiwan, that could destabilize global markets. 

More immediately, there are the risks that come with investing in an authoritarian government that is tightening control over business and society. 

Xi is clearly emphasizing a need to address the wealth inequality created by recent economic gains, even at the expense of corporate profitability. 

China has taken a heavy hand to regulation before, including an anticorruption drive that hit luxury and casino stocks hard in 2012 to 2014 and a crackdown on the online-gaming industry in 2017, but this drive is much broader and less coordinated—driven by different types of regulators, and it shows little signs of wrapping up. 

“The regulation doesn’t have a framework you can latch on to,” says Ruchir Sharma, chief global strategist at Morgan Stanley Investment Management. 

“It’s disorienting.”

China passed some of the world’s strictest data-privacy laws this month and is targeting anticompetitive behavior, like internet behemoths’ exclusivity agreements with small merchants and algorithms that can influence consumer behavior. 

Regulators have pushed e-commerce companies to raise compensation for gig workers and are exerting more control over content and entertainment. 

Also on the table: possibly eliminating the preferential tax treatment that internet companies have enjoyed and increasing pressure on businesses and the wealthy to give back more to society.

Over the long term, some of these regulations could mean more sustainable growth in the internet sector, which has been the scene of price wars, subsidies, and misdirected investments. 

But in the near term, “this marks a sea change, and is triggering a reassessment by investors of some of the big companies,” says Rajiv Jain, chief investment officer of GQG Partners, whose emerging markets strategy is underweight China. 

“ China Mobile used to trade at 40 times earnings, and every investor wanted to own it,” he says, “but as it got hit by regulatory pressure over the years, it dropped significantly—even before the implementation of regulatory sanctions” that led to its delisting.

A government-owned entity just took a stake in ByteDance, which owns TikTok, raising questions about how much political intervention investors should expect—and whether China should trade at a discount to other emerging markets, as Russia does. 

But China isn’t Russia; its size and breadth of market opportunities are far larger.

Plus, innovation is crucial to China’s ambitions to reduce its dependence on the U.S., which is why even those wary about the recent moves do not expect China to devastate its internet behemoths, which are a hotbed for emerging technologies like artificial intelligence. 

With the private sector accounting for almost 90% of urban employment and the digital economy accounting for 40% of China’s gross domestic product, most expect China to ease off or reverse course if its efforts begin to impinge on growth at a time when the economy is already slowing and as another round of Covid-19 restrictions hit. 

In fact, the People’s Bank of China has already been trying to ease strain on small and medium-size enterprises and said it would boost the amount of money flowing to smaller businesses and the economy.

As the Communist Party grapples with inequality, corporate profits may not be as juicy, but they won’t disappear. 

And China isn’t done with its experiment with capitalism. 

“In the long term, you can’t ignore China—and they do want foreign investment,” says Mark Mobius, a veteran emerging markets investor who now runs Mobius Capital Partners. 

He adds that the recent panic-fueled selloff has made China more attractive. 

“They want to become very powerful, and the only way to do that is by having a successful market economy.”

Underpinning all of this is a larger objective: to become more independent in a world turning increasingly hostile to China. 

That means China is intent on creating a deep and liquid capital market, one more accessible to domestic investors, who have not been able to access offshore companies like Alibaba and Tencent Holdings (700.Hong Kong).

“China is far from over,” says Justin Leverenz, manager of the $50 billion Invesco Developing Markets fund (ODMAX), which is underweight China’s megacap technology stocks and investing elsewhere in the country. 

“The bull case is very strong—and not incumbent on foreign investment. 

There will be a multiyear transformation of the asset allocation of the households in China that drive prices. Why would one not be part of this explosive opportunity?”

The Strategy: What to Buy

Beijing’s policy shifts and regulatory efforts are reshaping industries, which puts the behemoths—such as Alibaba, Tencent, and Yum China Holdings (9987.Hong Kong)—at risk of slower growth and crimped profitability in the near term, but opens up opportunities elsewhere, notably companies in areas like renewable energy, autonomous driving, hardware, and businesses helping to create a stronger middle-class.

These lesser-known companies—some big, just not giant, as well as smaller firms—are not as well represented in broad market indexes and are best owned through mutual funds with experienced managers who understand the changing dynamics. 

Investing with funds also allows individuals to sidestep logistical issues, like delistings, and is an easier way to access Hong Kong–traded shares and the vast onshore, or A-shares, Chinese market.


For a China-focused option, the $1.6 billion Matthews China (MCHFX), down 2% this year, has a strong long-term record, and lead manager Andrew Mattock sees opportunities not just in the internet platform companies but also in domestic software and hardware companies, consumer-oriented companies, and those that are part of the value chain for renewable energy and solar—two areas that the government is intently focused on bolstering.

Some of the best emerging markets funds have invested in China without overloading on its behemoths. 

The all-cap $147 million Wasatch Emerging Markets Select (WAESX), which has returned 19% this year to beat 97% of its peers, has been underweight China and veering toward smaller companies within the country, some of which could benefit as Beijing stresses social good over profits.

“Very large and very successful companies may have reached the limits [of profitability], so you may be better off in smaller companies that can go unnoticed,” says lead manager Ajay Krishnan, who owns Chailease Holding (5871.Taiwan), a Taiwanese company that provides financing to the small and medium enterprises that Beijing is trying to bolster, and chip maker Silergy (6415.Taiwan), since China is trying to reduce its dependence on the U.S. for the key input for advanced technologies.

The $2.1 billion Seafarer Overseas Growth and Income fund (SIGIX), which is up 4.8% this year, beating two-thirds of its peers, has been underweight China. 

But Andrew Foster, a longtime Asia investor, says the selloff has made China more investible than in the past five years because the market can no longer ignore the risk of investing in state-controlled companies. 

Foster has gravitated toward companies that are not against or aligned with China’s policy agenda, like drugmaker Jiangsu Hengrui Medicine (600276.China), which has a stable of oncology treatments, including one for liver cancer that’s up for U.S. Food and Drug Administration review and could help the company go global.

The Strategy: When to Buy

China’s most well-known companies are starting to look cheap to some U.S. investors, though the likelihood of volatility means there will be ample opportunity to buy. These three are among the ones to watch.

Alibaba

One of the world’s largest online retailer is also home to China’s dominant cloud computing business, and myriad others. 

Before the derailment of Ant’s IPO last fall, it traded at 30 times earnings; today, it’s closer to 15 times next year’s earnings, and has $73 billion in cash. 

That’s a fraction of what Amazon. com trades at, even though the two e-commerce giants both earned about $22 billion in fiscal 2020—and Alibaba’s sales are growing faster. 

Of course, Alibaba (9988.Hong Kong) operates in a country with an ambiguous rule of law, so some discount is warranted. 

But at less than a third of Amazon’s market value, the discount may be at an extreme—even if its profitability and growth prospects are lighter.

“Alibaba controls almost half of the e-commerce in the country and is at the center of making sure China has a vibrant economy moving from manufacturing to consumption,” says Victor Liu, senior research analyst at Causeway, who expects midteens earnings growth over the longer run. 

“This is still a company that has a lot of growth in front of it, just not as unbridled as before.”

There are company-specific risks that have nothing to do with China’s political efforts: Competitive pressure has been intensifying, and Alibaba’s aggressive investments to catch up with younger rivals like Meituan (3690.Hong Kong) and Pinduoduo (PDD) depressed near-term earnings growth prospects. 

The mean analyst estimate on FactSet for earnings per share in fiscal 2022 is now $9.50, down from $12.34 at the beginning of the year; analysts expect sales to rise 29%, to $143 billion, for the fiscal year ending next March.

Ironically, Beijing’s antimonopoly measures could force more discipline in Alibaba’s investments. 

The company also just increased its share buybacks to $15 billion from $10 billion. 

Alibaba’s stock is used as a proxy for China, and it has the most risk and the most issues with its business model—all of which will keep the stock volatile. 

But if it drops another 25%, where its price/earnings ratio is in the low teens, even wary money managers say they would bite.

Tencent

Tencent, which has fallen 30% in the past six months, is more appealing. 

The company’s core mobile-gaming business is under less competitive threat than Alibaba’s core business, and CEO Pony Ma has a better history of keeping a low profile and staying in the good graces of Beijing. 

Unlike Alibaba and other big internet companies, Tencent, whose WeChat app has more than a billion users, never listed in the U.S., and it has a record of being proactive in addressing government concerns. 

For example, it recently introduced a one-hour limit for children under the age of 12 on their games and limits in-game purchases. 

The impact of the crackdown aimed at younger gamers should be limited, since minors made up just 0.3% of gaming revenue in the second quarter.

There are risks, though: Its advertising business could be hurt if the economy slows, and as regulation dampens the cutthroat competitiveness that fueled some ad spending. 

Tencent is also a stealth venture capitalist, with successful investments in the likes of JD.com (JD) and Meituan, businesses whose valuations are also under pressure.

The risk of further intervention also persists, including losing its preferential tax treatment. 

If the tax rate increases to 21% in the second quarter from the 15.5% that Citigroup analyst Alicia Yap has modeled, she estimates a 3% hit to earnings. 

Yap has maintained her Buy rating, but cut her 12-month price target 12%, to 689 Hong Kong dollars—45% higher than recent prices—citing near-term pressure on the company’s business because of the fallout from regulation.

Tencent trades at 23 times 2022 earnings, near the trough for the company’s core online entertainment and advertising businesses over the past five years. 

That means there’s little value assigned to its fintech and cloud businesses or its investments, says Neuberger Berman Emerging Markets Equity manager Conrad Saldana. 

Despite the near-term risks, Saldana expects long-term earnings growth of 20% to 30% as the company makes money off its ecosystem and base of 1.25 billion monthly users.

Yum China

Even nontech companies have been swept up in the selloff. 

Shares of investor darling Yum China fell 5% in the past three months. 

Yum China has generated free cash flow every year since it was spun off from Yum! 

Brands (YUM) in 2016; it is extremely well run and has 7.5% of its market cap in net cash, providing a cushion amid the uncertainty, says Laura Geritz, who runs Rondure Global Advisors.

At 27 times forward earnings, the stock isn’t as cheap as the internet megacaps but also not as much in regulators’ crosshairs. 

Analysts, on average, expect earnings per share to grow 27% in fiscal 2021 to $1.95 a share, with revenue growing at about the same rate to $10.2 billion.

Yum’s price drop was amid another round of Covid lockdowns, but the company navigated last year’s lockdowns well, and its scale and experience should help it emerge as a survivor in a market filled with mom-and-pops, Leverenz says, adding that Yum could double its network in seven to eight years. 

Plus, China’s redistributive policies aimed at reducing housing, education, and healthcare costs should give lower-income consumers more money to spend on eating out. 

The average 12-month stock price target from analysts on FactSet sees Yum China’s stock 19% higher, at HK$570.

Ultimately, the message for investors is one of cautious optimism: China is still a major source of global growth, and home to diligent savers being encouraged to put more of their $75 trillion in household wealth into a stock market filled with companies well positioned for Beijing’s policy makers. 

That’s attractive terrain for long-term stockpickers, just one that requires a clear sense of the risks and careful footing.

Investors in China should beware Beijing’s unpredictability

The authorities are capable of turning their wrath on any company or sector that displeases them

Brooke Masters

© Ellie Foreman-Peck


When Alibaba debuted on the New York Stock Exchange in 2014, the $25bn deal was the largest initial public offering ever, valuing the Chinese ecommerce company more highly than Facebook and Amazon.

Breathlessly described as a “coming of age” for Chinese tech, its success prompted hundreds of other overseas listings by some of the country’s most innovative companies. 

Since the start of 2014, 769 Chinese companies have listed on exchanges outside the mainland, mostly in the US or Hong Kong, according to Dealogic. 

They’ve raised a total of $250bn, more than the $236bn amassed from new domestic listings over the same period.

Overseas investors have flocked to these newly public companies at a time when interest in Chinese securities is at an all-time high. 

Beijing’s early successes in containing Covid-19 and the addition of renminbi assets to global stock and bond indices have led investors to boost their total holdings of Chinese stocks and bonds by 40 per cent in the past year to more than $800bn.

Chinese groups such as Xpeng and Li Auto raised a record $46bn on overseas exchanges in 2020 and once appeared to be set to break that record this year. 

Such IPOs often attract investors seeking to cash in on the growing Chinese economy without the bother of holding foreign shares. 

The structure can also lull the unwary into thinking that investing in China is no different than putting money in developed markets.

That is a terrible mistake. 

Shareholders in Chinese companies lack fundamental rights and are buying into an arbitrary system where the rules can and do change overnight. 

A continuing fight about the way US-listed Chinese companies are audited underscores the lack of investor protections and could ultimately force Chinese groups to delist from American exchanges.

Overseas investors have recently seen ample evidence of Beijing’s unpredictability. 

The first big warning came in November when financial regulators unexpectedly suspended the planned listing of Ant Financial just days before what would have been the world’s largest IPO in Hong Kong and Shanghai.

The halt was initially seen as an attack on Jack Ma, the company’s founder, but it has become clear that Chinese authorities are cracking down far more widely. 

In March, a sudden tightening of vaping rules drove down shares in e-cigarette maker RLX Technology only two months after its US IPO. 

Last month, China’s cyber security regulator began investigating Didi Chuxing and pulled it from domestic app stores just days after it became the largest US listing by a Chinese company since Alibaba. 

Authorities also launched a probe of recently floated logistics firm Full Truck Alliance, and warned that all US listings face tighter scrutiny.

A few weeks later, the $100bn tutoring sector found itself in the crosshairs as companies that teach school curriculum subjects were barred from making profits, accepting foreign investment and listing on worldwide stock exchanges. 

Shares in the three largest US-listed education groups have lost about 90 per cent of their value since the start of the year.

Class action lawyers are scrambling to file suits on behalf of aggrieved investors, but their chances of recovery are much lower than they would be with a western company. 

Not only are managers and assets based in China, where US corporate and securities laws are effectively unenforceable, but investors don’t really own the companies.

Foreign ownership is officially illegal in many Chinese sectors, so companies that want to tap overseas cash set up “variable interest entities”, a structure made famous by failed energy group Enron. 

Essentially, investors buy shares in a holding company, often domiciled in the Cayman Islands, that purport to give them a share of the economic benefits created by the Chinese company but not operational control.

Chinese regulators have never officially blessed VIE structures, but they have largely allowed their use, one exception being a 2009 crackdown on online gaming groups. 

Still, the legal uncertainty gives Beijing a potent weapon that it can wield at any time, against any company.

Further complicating matters is a looming US clampdown on Chinese companies listed there. 

Congress passed a law last winter calling for companies to be delisted in three years if they fail to give American regulators access to their audited accounts, which Beijing currently prohibits. 

If that happens, overseas investors could be forced to sell back their shares at a loss.

With new US listings in effect frozen for the mainland tech sector, bankers are scrambling to redirect IPOs to Hong Kong. 

That does little to solve these problems. 

Beijing can still pull the rug out from under any sector or company that displeases it. 

Investors are rightly becoming wary. 

Just this week, the Chinese music streaming service Cloud Village yanked its Hong Kong IPO and SoftBank said it would cut back its investments in Chinese tech start-ups.

It is a truism that emerging markets are defined by their governance: successful investments align your interests with those of the government or a controlling shareholder. 

In China, that task is rapidly becoming harder. 

Many of the uncertainties were apparent even when Alibaba listed, but enthusiastic investors opted to discount them. 

Now they cannot be ignored.

Why Is COVID-19 Surging in America Again?

In US states with negligent or recalcitrant leadership, the Delta variant will have a greater negative impact on public health and the economy. People will die, visitors will stay away, businesses will not be able to stay open, and workers will be laid off again.

Simon Johnson


WASHINGTON, DC – Throughout 2020 and into early 2021, there was hope that with some luck and enough vaccines, it would be possible to end the COVID-19 pandemic in a quick and decisive manner. 

By this summer, it became clear that this would not happen in the United States. 

The Delta variant represents an unfortunate turn of events, compounded by many people’s unwillingness to be vaccinated.

In view of these developments, how should President Joe Biden’s administration adjust its COVID-related strategies? 

For the most part, the administration’s approach is on track and having the best possible effect under the circumstances. 

Staying the course and ignoring detractors is the best way forward.

The federal government is, of course, limited in what it can do about public health. 

Bipartisan support helped to produce several remarkably effective vaccines – the National Institutes of Health should score very highly in any assessment of its performance, including in how it mobilized and cooperated with private-sector companies. 

This is exactly how the government and business should work together in a national emergency to ensure the use of all available scientific firepower.

The US Centers for Disease Control and Prevention was hampered by political meddling and confusion at the very top throughout 2020. 

New leadership and a much better approach by the White House have brought the situation under control. 

Not everyone agrees with all the advice given, but there is a general recognition that weighing the evidence and being careful about people’s health are once again the CDC’s predominant considerations.

The Surgeon General has also been busy, strengthening public health and providing sensible advice across a wide range of issues concerning the pandemic and beyond. 

Following this leadership, private-sector companies are increasingly encouraging and even pressing employees – particularly when they interact in person with colleagues or assume public-facing roles – to get vaccinated.

The laggards in the effort to combat COVID-19 have been at the state level. 

Some states have set a more positive tone, with more health-care workers vaccinated and colleges that require vaccination for students and staff who want to be on campus. 

There are always legal challenges in America, but the argument that “I should be free to infect my colleagues with a potentially fatal illness” is so far gaining little traction with the courts.

Unfortunately, some state leaders have continued to treat COVID-19 as a political football. 

Perhaps they feel that this worked for them in 2020, when they could argue that “opening” activities was good for local economies, even if infection rates increased. 

But in 2021, post-vaccine, the situation is entirely different. 

Declining to follow advice from the NIH, CDC, and the Surgeon General now means discouraging vaccination, which will mean more infections, more pressure on hospitals, more deaths, and, one way or another, a more depressed local economy.

There are countermeasures that can be taken if low vaccination rates cause the disease to surge. 

But some state legislatures and executives oppose mask mandates and are lukewarm toward systematic testing in asymptomatic populations. 

The upshot is that in places with more negligent leadership, COVID-19 will have a greater negative impact on public health and the economy. 

People will die, visitors will stay away, businesses will not be able to stay open, and workers will be laid off again.

Perhaps recalcitrant state leaders will change their minds when COVID patients overwhelm their hospitals and intensive care units. 

But given the lack of political accountability in modern America, it is more likely that most of them will find excuses or distractions.

The tragedy is that the disease will continue to infect vulnerable people – killing them or making them sick for a long time. 

This is both completely avoidable and inevitable if health-care and home health aides are not 100% vaccinated. 

National leaders in the nursing home and senior care industry, and many at the state level, have worked hard to persuade all workers to choose vaccination, but there is only so much they can do.

Private-sector employers are faced with a tough choice – if they require vaccination, some workers will quit. 

Nevertheless, companies are increasingly likely to follow Delta Air Lines by imposing additional fees on unvaccinated workers and requiring more testing for those people.

The one federal agency that still needs to do better is the Food and Drug Administration, which did not move fast enough to approve new COVID tests and techniques that were appropriate for screening populations and reducing the spread of infections. 

True, the FDA’s performance has improved – including with full approval of the Pfizer-BioNTech vaccine and now consideration of booster shots. 

The situation around testing for COVID has also become clearer, at least for the time being. 

But a new head of this key agency needs to be appointed by Biden and confirmed by the US Senate soon.

The Biden administration inherited a public-health emergency that had been badly mishandled. 

Its response has been strong and effective. 

New variants continue to pose a threat. 

The only way forward is to follow through on the bipartisan commitment to free and effective vaccines for everyone.


Simon Johnson, a former chief economist at the International Monetary Fund, is a professor at MIT's Sloan School of Management and a co-chair of the COVID-19 Policy Alliance. He is the co-author, with Jonathan Gruber, of Jump-Starting America: How Breakthrough Science Can Revive Economic Growth and the American Dream and the co-author, with James Kwak, of 13 Bankers: The Wall Street Takeover and The Next Financial Meltdown.