The End of EM (part I)
Beijing, China
As China’s 20th National Congress in 2022, President Xi received an unprecedented 3rd term and clearly outlined China’s global geopolitical strategy shift from passive to assertive. China would now defend its interests and take positions in situations like the Ukraine War, US trade policy and further expand its regional sphere of influence. Hence most media coverage of the event was inline with the Oct 2022 issue of The Economist portraying Xi as the “Most Powerful Man in the World”. At 25i, we were thinking about a different magazine cover from the year 1978: China’s then-premier Deng Xiaoping voted as Time’s “Man of the Year” given his reform program and opening China to the world. We feel these reforms led to, over the next 50Y, a shift to Asia for both world politics and global manufacturing which drove the formation of emerging markets as an asset class. So Xi’s 3rd term, from our perspective, doesn’t just mark the start of an extended “Xi era” but really the end of the Deng era and with it, the end of China’s “rising” and as a knock on effect, the end of emerging markets (or “EM”) as we know it. We explore these ideas in a 3-part blog.
Part 1: The Deng Era in brief
Let’s start with the Deng era and what it meant in the areas of global politics, manufacturing and investing. In 1976-77, Deng completed his incredible return to power as he went from being a political outcast (Mao and the Gang of Four demonized him given his desire for reforms) to China’s paramount leader after Mao’s death. Once he asserted control, he effectively ended Mao’s version of communism and embraced a form of capitalism (which helped win the Time magazine distinction - he won again in 1985 for “sweeping economic reforms that have challenged Marxist orthodoxies”). Its difficult today to put these changes in perspective but in 25i’s view, Deng’s reforms were the beginning of the end of the Cold War as one of the two largest communist economies effectively said ‘our system doesnt work’ and opened past leaders (Mao) to public criticism. This dramatic shift in world politics would lead, over the next 15 years, to the collapse of the communist world and the US emerged as the world’s sole superpower. Subsequently, the US’s economic policies set the new benchmark for countries to measure their global standing.
On manufacturing, the opening of these previously closed communist economies (China, USSR, Warsaw Pact countries) provided cheaper production options and potential new consumer markets for global multinationals. Other countries (such as in Latin America and Southeast Asia) followed suit to remain competitive and attract global capital that searched for higher returns as US interest rates fell from their 19% peak in early 1980’s (rates fell partially due to falling inflation driven by falling marginal costs of production). All these global forces led to the hollowing out of the European and North American manufacturing bases (at least light or low value added goods) and rise of a China-centric manufacturing world (simply look at the “Made in” label of an average product in Walmart or Canadian Tire). Thus China became the dominant global manufacturer which led to its no 2 rank globally in economic GDP after the US. The incredible wealth generation from this structural change is attributable to Deng and his policies from 1977-78. Its hard to find another country in history with such growth in economic and political power in such a short time period.
Finally, on investing, in 1978, the universe for most institutional players (as this is before mass market mutual funds), consisted of effectively G20 countries (North America, Europe, Japan and Australasia). Everywhere else was considered “Third World” or “LDCs” (least developed countries) as either countries like China were off limits to foreign investors or the local markets were too small/bureaucratic to invest. In 1981 though, then World Bank economist Antoine Van Agtmael coined the term “emerging markets” to reflect a direction of travel for growing but poor countries and China fit this definition (though Hongkong was the only option at that stage). EM as an investment theme, though, didn’t gain wider acceptance until the fall of the Berlin Wall in 1989 which galvanized investors as the Warsaw Pact countries embraced the West and mutual funds offered easy access for global investors. Slowly but surely, emerging markets grew from a speculative to an established asset class now considered “core” for any global pension or asset allocation fund. China, though non-existent in market value terms in 1989, is now the dominant country in the EM index at over 40% of the equity value but over 60-70% of the daily traded value (in USD terms). So effectively, for global investors, if you bet on EM, you are betting on China.
And so, after 40+ years of Deng-era reforms, China is the worlds leading manufacturing economy, 1 of 2 super powers and second largest economy in the world after the US. And despite its EM-level status, its stock market lists some of the largest and advanced technology companies in the world. But that era has now ended.
The next blog outlines how it ended under President Xi.
Thanks for reading.
