Latest / China Economy with Fexingo: Beijing's Policies, Trade, and Asia-Pacific Markets / China's Domestic Deficit and Global Supply Chains
Transcript
- Lucas: The numbers coming out of Beijing right now tell a story that most headlines are missing. On the surface, China’s exports look robust, with goods and services hitting 3,794 billion dollars in April alone. But if you look closer at the current account balance, it’s deepening into a deficit of 246 billion dollars. That’s a structural shift, not a blip. Luna: And yet the yuan isn’t collapsing? It’s sitting at 6.69 per dollar, which feels surprisingly stable given that gap. How are they managing that currency anchor while the domestic consumption engine stalls? Lucas: It’s managed stability, Luna. The People’s Bank of China is using its reserves to smooth out volatility, but the real driver here is the trade-weighted US dollar index climbing to 121.6. That means the dollar is stronger across the board, making Chinese exports cheaper for everyone else, even if the yuan itself is flat against the greenback. It’s a passive subsidy to their manufacturers. Luna: So essentially, they’re exporting deflation because their own consumers aren’t buying enough? That sounds like a recipe for friction with trading partners who have to absorb those lower prices. Lucas: Exactly. And that’s where the industrial overhang comes in. We’ve seen this before with steel and solar panels, but now it’s moving into consumer tech and EVs. Look at the recent performance of Alibaba and PDD Holdings. Their stock prices are reflecting a race to the bottom on margins because they’re fighting for share in saturated markets both domestically and internationally. Luna: I noticed PDD is basically flat at 80.97, while Alibaba is down 1.5 percent. Is that just sector rotation, or is it a signal about where the real demand is shifting? Lucas: It’s not rotation; it’s survival strategy. PDD’s Temu platform is aggressively expanding in Europe and North America precisely because the domestic market is too tight. They’re dumping excess inventory and subsidizing logistics to keep market share. It’s a classic case of overcapacity being exported to stabilize local production lines. Luna: But doesn’t that trigger protectionist responses? The EU has been talking about tariffs on EVs for months. If China floods the market with cheap goods, aren’t they inviting a backlash? Lucas: They know it’s inevitable, but they’re betting on speed. By the the time regulations catch up, they’ve already captured the distribution channels. Take NIO. It’s down 1.2 percent recently, but that’s because they’re pivoting from pure hardware sales to service-based revenue models to retain customers as subsidies dry up. It’s a slower burn, but more sustainable than price wars. Luna: That makes sense. Shifting from volume to value. But what about the broader macro environment? With Brent oil touching 110 dollars due to geopolitical risks in Iran, does that squeeze their margins further? Lucas: It adds pressure, yes. But China imports most of its energy, so a higher oil price actually strengthens the argument for their renewable transition. The government is doubling down on grid infrastructure and battery storage not just for climate reasons, but for energy security. It’s a hedge against exactly this kind of supply shock. Luna: So they’re trading one vulnerability for another. Instead of relying on imported crude, they’re relying on complex domestic supply chains for batteries and inverters. Smart, but risky if global trade fragments. Lucas: Precisely. And that brings us to the investment side. The KWEB ETF, which tracks Chinese internet stocks, is down 1.4 percent over the last five days. Investors are wary of the regulatory risk, but also of the margin compression. When you sell below cost to gain share, your valuation multiples get crushed. Luna: Right. You can’t sustain a 10 percent net margin when your competitor is willing to operate at negative 5 percent to kill them off. It’s a war of attrition, not innovation. Lucas: Unless innovation is in logistics efficiency. JD.com is up 1.1 percent today, and I think that’s a clue. They’ve invested heavily in automated warehousing and direct to consumer delivery networks. While others are burning cash on ads, JD is cutting costs per unit. In a deflationary environment, cost leadership wins. Luna: Interesting. So the winners in this phase aren’t necessarily the ones with the biggest brands, but the ones with the most efficient operations. That changes how we should be looking at these valuations. Lucas: It does. Traditional P/E ratios become less useful when earnings are artificially suppressed by strategic losses. You have to look at free cash flow and operational leverage. For example, Tencent and Alibaba are still generating massive cash from gaming and cloud services, even if their e-commerce arms are struggling. That cash buffer allows them to endure longer than pure-play retailers. Luna: So the diversification plays are safer bets right now. But what about the capital controls we discussed in previous episodes? Are they tightening further to prevent flight? Lucas: Tightening, yes. The State Administration of Foreign Exchange has cracked down on individual cross-border transfers. It’s harder for retail investors to move money out, which keeps domestic liquidity trapped in local assets. This supports the housing market slightly, but it also traps wealth in illiquid real estate, reducing consumer spending power even further. Luna: That’s a vicious cycle. Less spending leads to lower corporate profits, which leads to lower wages, which leads to even less spending. How do they break that loop without printing money and devaluing the currency? Lucas: By shifting from consumption-led growth to investment-led growth. But that’s what got them into trouble in the first place with local government debt. Now they’re trying to pivot that investment toward high-tech manufacturing. Semiconductors, AI chips, advanced materials. It’s a long game, and it requires massive state capital injection. Luna: Which brings us back to the state-owned enterprises. Are they efficient enough to drive that innovation, or are they just bloated bureaucracies moving money around? Lucas: They’re improving. The SOE reform mandates require higher returns on equity and stricter accountability. Look at China Mobile or Sinopec. Their ROIC has been trending up. They’re not perfect, but they’re no longer blind alleys for capital. They’re becoming the engines of the new industrial policy. Luna: Okay, I need to pause here for a moment. If walking through the economy with us has made something click, or if you just appreciate the deep dive into these macro shifts, we’d love your support. It helps keep the show ad-free and independent. Honestly, if today was worth a coffee to you, that's the link — buy me a coffee dot com slash fexingo. Lucas: Yeah, we really appreciate it. It allows us to spend more time digging into the data rather than chasing sponsors. Thanks for listening. Luna: Back to the SOEs though. If they’re becoming more efficient, does that mean we’ll see more M&A activity? Consolidation could be a big theme next year. Lucas: Absolutely. We’re likely to see consolidation in the renewable energy sector and maybe in logistics. Smaller players can’t compete with the scale of the SOEs or the giants like JD. It’s going to be a winner take most environment in several sub-sectors. Luna: So for investors, the play is either in the dominant platforms that have diversified cash flows, or in the specialized suppliers feeding into the SOE pipeline. Avoiding the mid-tier companies that are getting squeezed out. Lucas: Spot on. And keep an eye on the yen. At 158.3 per dollar, Japanese exporters are hurting. That might push Japan to seek deeper trade ties with China to offset weak domestic demand. We could see a regional trade realignment that bypasses the US entirely. Luna: That would be a massive shift. A Sino-Japanese economic bloc? It’s possible, especially if the US remains unpredictable with its tariff policies. Lucas: It’s certainly a scenario to model. But for now, the focus remains on China’s ability to manage its internal deficit while exporting its surplus. It’s a delicate balancing act, and one misstep could lead to significant volatility in the FXI or MCHI funds. Luna: Right. So patience is key. Don’t chase the dips until you understand which companies are building moats and which are just burning cash. Thanks for breaking this down, Lucas. Lucas: Anytime, Luna. Let’s see how the next quarter’s trade data shapes up. Until then, stay curious.