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Market participants are closely watching China’s response to the war in Ukraine. The crisis has upended the geopolitical landscape, fractured tenuous alliances, and sharpened focus on strategic sectors. Host Thomas Mucha speaks with Santiago Millán, Wellington’s Hong Kong-based macro strategist, about his perspectives on China’s approach to Ukraine, climate change, and ongoing COVID-19 challenges.
THOMAS MUCHA: As listeners of this podcast have deduced, there’s probably no bigger geopolitical issue, at least from a market perspective, than the US/China relationship. The world’s two biggest economies, key military, diplomatic, and cultural powers, and now apparent great power rivals. How these two giants of the international stage manage their differences and look for areas of cooperation is likely to be a defining factor of global stability for years and, yes, decades to come. Now, given the size and importance of China, we obviously have a lot of perspectives on the topic across Wellington, it’s a subject that touches nearly every investment decision we make, across every asset class. And where China is going affects how we think about a variety of macro, market, and geopolitical issues. I’m joined today by one of the firm’s most important voices on the topic, macro strategist Santiago Millán, who from Hong Kong leads the firm’s efforts in thematic and sector-based research on China and other countries across Asia. Santiago, welcome to WellSaid.
SANTIAGO MILLÁN: Thank you, Thomas.
THOMAS: Let’s start with this idea of great power competition. What it looks like in Washington, what it looks like in Beijing. Now, as I follow the national security debates here in the US, there’s been a big change in the US/China relationship in recent years, with a real focus on this long-term geopolitical competition and all kinds of new rhetoric coming out of DC. We’ve also, of course, seen more contentious trade, economic, military, and diplomatic relationships develop. So Santiago, I’m wondering, how does this great power narrative play in Beijing?
SANTIAGO:Yeah, that’s a good question, Thomas. I would say that, perhaps from the Beijing perspective, China didn’t want to be thrown into the eye of this conflict so quickly. I would say that also, China, from their perspective, feels very much like a country under siege. Perhaps one of the things that China was looking for when it made some of the biggest strides to promote globalization and its own insertion into the international community was a sense that it would be very readily accepted and admired by the West, and it’s finding that, instead, in opinion polls a much more hostile reaction than they expected. So this is intensifying the conflict.
THOMAS: Now, these tensions are playing out, of course, in the economic relationship. Here, national security is playing a larger role in the US policy environment, with a greater focus on supply chain resiliency, more attention to strategic sectors with dual-use civilian and military applications at the fore, including semiconductors, a variety of emerging technologies, including next-gen communications, space, biotech, artificial intelligence, quantum, and a bunch of other industries that are critical to future global economic and military balances of power. So, how does China view these critical sectors, these key industries, and what do they mean for China’s economic future?
SANTIAGO:China has been very clear about its industrial policy to promote technology for quite some time, as you know. And indeed this was what created some of the conflicts to begin with. China had their famous Made in China 2025 program.
THOMAS: The blueprint!
SANTIAGO:The blueprint that highlighted exactly these strategic industries. And when there was, again, a negative reaction from the United States, in particular, but also from lots of other countries who saw this as a form of protectionism, China backed away from this in name, but a lot of those policies still are in place. And essentially what China sees is that these are the industries that are strategic in order for the country to really move to the next level of economic development, move out of the middle-income trap, if you will, and also make sure that it is independent in the economic sense.
THOMAS: So does China feel that the United States is trying to contain it in some of these critically important sectors?
SANTIAGO:That’s very much the view. And I would say that there’s a dialogue internally with a spectrum of people who believe that engagement and integration is the most viable policy, all the way to people who are very much isolationist, kind of similar to a mirror of what’s happening in the United States. And as it is happening globally, the tide seems to be turning in favor of those who are more isolationist and more conservative.
THOMAS: Yeah, that’s obviously having impacts on the US/China relationship. So, too, is the Ukraine conflict. So how do you assess the strains that this ongoing geopolitical crisis in Ukraine is placing on China’s diplomatic relations with the US, but also its, the US’s Western allies, particularly in Europe, which by some measures is China’s largest trading partner.
SANTIAGO:It really puts China in a very complicated situation, and I would highlight also a situation that is very, very different from the way that the world looked just a few years ago. Maybe rewind to the year 2020, and what we were looking at before the pandemic, or even during the early stages of the pandemic, was a situation where Europe really looked like the part of the world that would balance the increasingly antagonistic relationship between China and the United States. China and Europe were about to sign the comprehensive agreement on investment, which was essentially an investment agreement that would greatly facilitate the economic integration between these two important economic areas. And what has happened more recently is that not only has that relationship deteriorated, but China is in a situation where it really does not want to take sides in the Ukraine conflict. However, as you well know, in the view of the United States and the Western allies, there is no such thing as a neutral position would be viewed as a position that is in favor of Russia. You add to this the fact that China has a very deep and large economic relationship with Russia, not only on the energy side, but also as a key supplier of lots of technology goods, including military goods, and of course, dual-use goods, and that makes it, complex. So China’s position here is extremely delicate. Maybe one place where I would push back a little bit though is that I would say that China is also, despite this, not as isolated from the rest of the world as one may, may think, in part because the rest of the world is not so fully decided. It does not necessarily view what Russia is doing as something that they approve of, but on the other hand, they’re very reluctant to take sides because they don’t really know what are the costs and benefits of that for the future. And that means that while the US and the allies might be quick to take actions to isolate China, and in fact are doing so, the rest of the world is probably going to be much slower in that action.
THOMAS: Yeah, I find that to be a very interesting geopolitical dynamic right now. There’s a lot of support obviously in the West, the Transatlantic Alliance, with Japan, with Australia, with the Five Eyes Alliance, but much of the so-called global south is remaining non-aligned. I’m curious, what does that tell you about China’s geopolitical influence globally?
SANTIAGO:It speaks to the part of China’s geopolitical alliance that it had been working on for a very long time, and I would say that these are the fruit of seeds that were sown in, for example decades of the first foreign trip by the foreign minister of China always being to Africa, the Belt and Road Initiative, and all of these aspects. However I would say that while that is working, I would say that the vision that China had for its foreign policy would be one where it would be having good relationships with the entire world, and not just a part of it.
THOMAS: I was in Brussels in recently, meeting with senior-level US, EU, and NATO officials. Obviously, the topic of China’s economic relationship with Russia was a key area of discussion among these policy makers. how do you think about China’s attempts to balance the two markets of Russia and the rest of Europe, given the latest geopolitical developments?
SANTIAGO:China is in a very tricky position here. Its two most important economic relationships by far are with the United States and with Europe, and the Ukraine situation puts China in a difficult position with both of them. On the one hand, China has had, recently, publicly announced a very strategic partnership with Russia, in quotes, “that has no limits.” On the other hand, its economic relations with Europe are an order of magnitude higher than that with Russia. What you see China doing is trying to walk the middle ground, but conflict does make things a lot more difficult. There’s a lot of pressure coming from Europe and many other places to outright condemn Russia, which China has not done. I think the good outcome here would be if the conflict stabilizes in Ukraine, and nothing occurs for China to be forced to choose one way or another. There is some possibility that that will happen, and we need to observe the changes to see if that risk is still there.
THOMAS: That brings me to my next question, which is around this idea of geopolitical risks in this environment. And how does China, or how does the region, more broadly, view these increasing hot spots around region, South and East China Sea, North Korea, how big a risk is this to the US/China relationship in general?
SANTIAGO:From an investment perspective, these are very difficult issues, because we don’t really have a model for assessing what is the probability, at least not one that’s empirically based. You have to imagine different scenarios. And what do those scenarios look like? Well, brinkmanship I think is important to realize that it’s happening from both sides. So just as there are lots of flights over certain territories and things like that happening from the Chinese side, we also have not only the official actions that come from the military and from the current government, but also actions from people in the Congress that seem to be in a race to show credentials of being tough on China.
THOMAS: You know, we talked earlier about the importance of strategic sectors, how China views them, how the United States views them. I mean the, the signals that I get from policymakers here are that they want to do this in a measured way, they want to do this in a way that’s telegraphed to the markets, that is done over time to create the least amount of friction in the global financial markets and geopolitically. But to me, these increasing geopolitical risks need to be monitored, because these are the points where we could have a sudden rupture in US/China relations.
SANTIAGO:One thing that I would add is that even from the Chinese perspective, and definitely from the perspective of the rest of the world, there are many moving parts and they’re not necessarily well-coordinated. Just as in the United States, you have actions coming from the executive branch, the Congressional branch, all sorts of law enforcement doing their own thing. In China, you also have different regulators and different parts of the government doing different things, sometimes in conflict with each other, and all of the time causing the risk that there will be a misunderstanding that will take us to a higher level of tension.
THOMAS: Are you suggesting that politics is messy?
SANTIAGO:Not at all.
THOMAS: So Santiago, should we be preparing for a world where the US and China have no economic linkages?
SANTIAGO:Well, I wouldn’t be ready to go quite so far. And in fact, while I see further integration as unlikely, I think it’s important to note that there are a lot of businesses in each other’s economy that are thriving. If you look at the US presence in China, you can see consumer-goods companies selling coffee and food, and technological goods, and even electric autos. And all of those create constituencies that want to preserve these economic relations. And also, even on the political side, while this is not a dominant force, you can see lots of very influential people in diplomatic circles and in other types of political circles who are arguing very forcefully and convincingly that integration is the preferred path. And also in China itself, I wouldn’t view China as an isolationist place, or having an isolationist policy, despite this idea of desire for independence. But that doesn’t mean that they don’t want to allow an integration with the rest of the world. It’s still viewed very much as a valuable thing on both sides.
THOMAS: So there are paths to repairing the US/China relationship?
SANTIAGO:There are, definitely. I think that they require a lot of things to go right. But absolutely, there are paths and there’s also certain aspects and people that are willing to walk those paths.
THOMAS: So what are the long-term prospects for the, the Chinese economy then, in this era of great power competition? You know, from a market perspective, where do you see the winners, where do you see the losers as this geopolitical contest intensifies?
SANTIAGO:The first thing I would say is that the market is not the economy. So, I would separate those two. And I would say that from the economic perspective, if you think about the ingredients to make a fantastic development story, they’re still there. The question is, are they going to be mixed in the right way so that it actually happens? And that was something that really, I had very little worry about for a very long time of following this and trying to predict the way this would go. If you had asked me what is the dominant ideology, the dominant ideology is pragmatism. If you combine a pragmatism and a professionalism with the really good ingredients for development, then you get development, and frankly I think that’s what we have seen even until today, backward looking, the story is, I think, even more impressive than a lot of the optimists were thinking. Now, the question is whether this turn of geopolitics, and as you say, raising national security and other ideological issues, including zero COVID, which is something we haven’t talked about above these pragmatic needs for development, that is a worry that I would say is still not my base case, but that I think about much more than I did in the past.
THOMAS: What parts of the Chinese economy then benefit from these developments that we’re seeing with national security leading? Does this make it a better economy, does it make it a more efficient economy?
SANTIAGO:Yeah, that’s a good question. Maybe I’ll, I’ll say one thing, which is that the part of the Chinese economy that excited me the most and probably still does, and from a medium-term perspective, is services. If you think about it, China is the largest manufacturer in the world, it’s the largest producer of goods in the world by volume, or value, or however you want to measure it. But it’s not the largest economy. So by definition, what’s missing in the Chinese GDP is services. And you see it also in the industrial policy, which is very clearly targeted towards manufacturing that you can touch. Essentially if you can touch it, that will benefit. So to your question on how does this affect the economy, I think that this means that the future for development and probably the investment opportunities are going to be much more favorable in, again, industry and manufacturing than they are in services. There’s always the possibility definitely that my view of a lack of oxygen in the service sector, could be wrong, and if that’s the case, then the runway for growth there is so big, as big as it’s ever been, that investors will definitely have time to look into that and invest for the long term.
THOMAS: All right, well you’ve briefly touched upon COVID, I want to dig into that a little bit more. Great power competition is both immediate and a persistent challenge. COVID is a much more immediate challenge for the Chinese economy. And you know, how are you thinking about its impact on the Chinese economy in the short run?
SANTIAGO:China again is in a very tricky spot with respect to COVID. I would say that COVID policy is, ironically, a victim of its own success. What do I mean by that? The problem is that before omicron, COVID was simply not contagious enough to overwhelm the isolation and contact tracing strategies of the Chinese government.
THOMAS: It was working.
SANTIAGO:It was working fantastically. Who would have predicted that the COVID epidemic struck, and it started in China, that China would become, instead of hobbled by it, the manufacturer of last resort? And what you saw was that Chinese exports gained massive amounts of market share, because zero COVID in China was keeping the factories open, until it didn’t. And what changed was that omicron is roughly three or more times more contagious, and when it comes to epidemic prevention you have to think in terms of exponential numbers. So, while the first variants of COVID would produce four or 16 cases omicron is producing orders of magnitude more, and that means that all of this gets quickly overwhelmed. Now, this would tell you that the logical thing to do is to shift from a containment to a mitigation strategy. But there are two big obstacles to that. The first one is ideological. The Chinese government has clearly stated that zero COVID is the only morally acceptable position, and that anything but the strictest of containment is something that shows disrespect towards the lives of people, and particularly old people.
THOMAS: So it’s the state’s responsibility to take care of its citizens in that view?
SANTIAGO:It is the promise that it has made. . And then, there’s also another big issue, which is that if you look at elderly vaccination rates in China, they are dramatically low relative to what you would want. The main reason for that is that elderly people, or people in China, quite frankly, until recently, had very little reason to believe that they would come into contact with COVID.
SANTIAGO:And therefore, getting vaccinated was kind of a waste of time. And the people who were least likely to get vaccinated were those who were the most worried about the side effects of vaccination, ironically also those who were most vulnerable to the disease. And at this moment, the problem is that resources are not multipurpose, and there is a tradeoff between spending the resources on isolation capacity and on daily testing of tens of millions of people, versus using those resources to vaccinate. So it’s a very tight corner that that the government has backed itself into.
THOMAS: So, what does this mean for the short-term economy then?
SANTIAGO:For the short-term economy, this means that the base case is to muddle through more of the same, and that means periodic lockdowns that have a great deal of the country essentially stuck in this type of situation. I foresee this happening for at least six months.
THOMAS: What about the risk of social instability as people get increasingly frustrated about being locked up, about not having access to the outside world? I mean is that a concern?
SANTIAGO:I would say is definitely always a concern, but I wouldn’t be too; it wouldn’t be high up on my list. And there are a few reasons for that. I think the first one is the geopolitics itself. When we started this conversation, you asked me how does the geopolitical conflict look from inside of China, and I said it feels like a country under siege. And this is generating a huge amount of nationalism. And as it does everywhere, people will rally around what they have today. The other thing that I would say is that there’s still, despite all the lockdowns and the suffering that’s happening, a very strong belief, a natural, genuine belief among the population that zero COVID is the right thing to do, and that therefore a lot of these costs are indeed necessary, because the alternative would be even worse. And finally, what I would say is that coming into this, the Chinese government had extremely high approval ratings, because on almost all other dimensions, the Chinese government has, until recently, been actually delivering pretty good results in terms of daily, day-to-day lives of people improving year after year, and a vision, again, at least up until now, that this will continue into the future. China is a place where parents feel like the future of their children has some sort of chance of being better than their own lives, which is something that as you know, is difficult in many places in the world.
THOMAS: All right, so that’s the short-term, I mean, and I know it’s, this is a difficult question, because we’re still going through this. But how do you see the long-term implications of COVID playing out on China’s economy.
SANTIAGO:In the long term, one of the biggest questions that I have is what are the consequences of long-term isolation of people to people contact? People to people contact, I think has been one of the most important, aspects of keeping not just the US/China relationship, but the relationship of any country with the rest of the world. And one of the biggest surprises to me has been how well it’s working in the economic sense. And that makes me worried about the long term. What do I mean by this? If you had asked me in 2019, what do you think will happen to China’s exports if people stop going to China because they have to quarantine for three weeks in order to get there, and it’s impossible otherwise? I would have told you China’s exports will collapse. Instead what happened was that they reached record levels, and they found that if nobody went to the trade fair to look at the products, they could have everything virtually, and it worked perfectly. So back to your question, long-term consequences of COVID. I think already, we’ve done a lot of damage, and we’ll only find out over the long term how big it is in cutting off those flows, and then my worry is that even when COVID is over, that a lot of the friction of people-to people contact is already gone.
THOMAS: All right, well obviously COVID is a long-term factor for China. So, too, is climate change, a key concern in China. I know this is a big area of your research as well. Now, China has been a leader in decarbonization efforts. It’s been a dominant force in renewable technologies, and supply chains in particular. It’s been very forward looking on the policy front. From your seat Santiago, what’s working in China with regard to decarbonization and what are you expecting here over the short, medium, and long runs?
SANTIAGO:Well the first thing, if we put the two topics of geopolitics and decarbonization together, I think that this is a tragically lost opportunity where I was hoping there would be the point of cooperation between China and the world.
THOMAS: It hasn’t played out that way.
SANTIAGO:It hasn’t, unfortunately. But as far as internally, I think as you say, one of the underrecognized things about China is the fact that China has been playing, I think, a very constructive role in the global energy transition. I say this despite the fact that in the short-term, China’s coal consumption is increasing. And I know that’s a big point of contention. In my framework, I think we need to normalize that by where China is on the development scale, and also by the fact that China is overwhelmingly, as you say, the biggest producer of renewable energy capacity in the world for both itself, in terms of installations, and the exports. Putting this together with national security, I think that does create, problems of dependency that are going to be confronted in other ways. And then the last thing that I would say about, China in terms of decarbonization is that it is very interesting from the financial perspective. Both because of the fact that China now has the largest carbon trading platform in the world, even though it’s not really accessible to investors, it probably will be. And also because it has, at one point, and still very large, green finance system and framework in operation. So, from all of those perspectives I think China is very interesting, and also vulnerable, I would and that’s a big important reason why China is acting.
THOMAS: Yeah, I think renewable technologies, renewable energy, are one of these strategic sectors that both countries see as being so important to the future. So I’m hopeful too that there’s some scope for coordination in this area. My gut tells me, however, that competition is dominant, even in an area of mutual cooperation like this.
THOMAS: How would you describe your thinking about China and your research process? This is one of the biggest, most complex, most challenging topics in financial markets today. What’s your what’s your philosophy here?
SANTIAGO:Well, I would say the first one is that I’m only as good as the people that I talk to. And, one of the, I would say privileges of being at a place like Wellington is not only access to external resources, but we have dozens of experts on different aspects, either because of deep experience in China itself, or because they are global experts in fields where China has a lot of relevance. And so, I would say that my process is not to know more than anyone else, but to try to listen more than anybody else, and try to bring perspective as well. There are many topics and obviously China itself, where there are people who will probably know a bit more, and where I can bring investment solutions and ideas to the table is by connecting different dots, by listening to the experts, and by bringing new perspective.
THOMAS: Yeah, it’s one of those topics that you could study every day for your entire life, and only scratch the surface. It’s that deep and that complex.
So how has this changed over the past two years in particular as COVID, geopolitical strains, and other tectonic shifts have hit the world and China, of course? What impact has all of this had on how you look at this country, and this market?
SANTIAGO:Yeah Thomas, well in short, I haven’t been to mainland China in two and a half years. Now, fortunately, we have a lot of contact with the mainland. And therefore, there are a lot of different points where we can get color on the situation. And also, a diversity of views can be preserved. I think that’s one of the most important things about the China research, and it fits very much into the process here at Wellington Management, where there isn’t one individual firm view. I have to admit that when we don’t see things firsthand, we by definition are forced to imagine them, and our imagination can sometimes play tricks on us. Being aware of that, I think, is part of the research process itself.
THOMAS: Yeah, I agree, I’ve just started traveling again recently, and there’s nothing like being on the ground and witnessing with your own eyes and talking to people on the ground. That’s where the real truths are, and it’s been a challenge to do this from a chair for two years. So what has surprised you most as you watch China develop over the years? Is there anything that really jumps out at you?
SANTIAGO:I would say, initially, China surprised me by being different, and then it, I would say held onto that characteristic. And maybe the only surprise would be one day when China stops surprising me, that would be a surprise. And you know, the surprises are all over the place, including, you know, very positive surprises about how much China embraced incentives and markets and development at some point. And other also surprises about how much China can swing in different directions at different times. So just won’t stop surprising, I think.
THOMAS: So, we don’t have a single view on China, we have a lot of, you know, a multitude of perspectives. But you’re clearly at the center of a lot of this. How did you end up in this key position at Wellington?
SANTIAGO:Frankly, it was really by accident. I joined Wellington 20 years ago as a global emerging market analyst, and frankly, China was not even a big part of the universe back then. There was a mentor here who did the China research, Spencer Glendon, many people have heard of him. And he took me to China for the first time, and I was fascinated by how different it was. I came back to Boston and I said I just learned about Latin America and India more than I ever have. in the past two weeks, more than I have in the past 10 years, and people were looking at me strange. Because they said they you just went to China. And that was really the beginning of my journey trying to understand what is it that makes this place so different from the rest of the world? And it’s taken me on this fascinating journey since.
THOMAS: That’s interesting, what did you learn about Latin America and India while you were in China?
SANTIAGO:Well, I would say that the most important thing was that I finally had something to contrast. When you only see the same type of system, when you only see the same type of thing, it’s very difficult to understand what is special about it. So to give you one example that really caught my eye, and that was unexpected, it was the level of competition that I saw in China. I’ll give you a small anecdote. The first time I visited, I went to outside of a third-tier city to visit a very simple factory. And it was sunflower seed packaging. They would take the sunflowers, seeds, sort them, and put them into packages. And I asked the business owner, how is business doing? And he said it’s terrible, and I was very confused, because at that point, China was growing over 10 percent, and I said, why? And he said, you have to understand that last year, or three years ago, we had about three competitors, and now we have something like 30 competitors. And that was something very different from the business structures and industry structures that I had seen into the rest of the world. And like that one difference that I saw, I can now point to 100. And those differences, I think, help me understand the rest of the world, and vice versa. One of the things that I think I and others do at Wellington that is unique in terms of China research is to bring perspective, and a global perspective to these issues can help us understand them a lot better.
THOMAS: I want to end here with a, a more personal question, and you know, if you weren’t Wellington’s China macro strategist, and I’m glad you are! But if you weren’t that, you know, what would you be doing with your life?
SANTIAGO:Well, that’s a good question. I think that I would be pursuing topics that would be as difficult, but hopefully also as productive, as China research would be. And I would think that the top of my list there would be climate.
THOMAS: So why does climate interest you so much from a research perspective?
SANTIAGO:I see climate, along with geopolitics, of which China is a part, as the fundamental driving force that will shape the structure of the global economy for years to come. This makes it hugely important, not just for policy, but also for shaping asset prices, and relative prices. From the energy transformation will come a different economy, and in many ways, we have ample warning, or ample forecast of where those changes will be most acute and most pronounced. And we can invest along with the footprint of those changes, just like I think we’ve been able to invest along with the footprint of the global changes that China has brought as it emerged as a giant in the global economy.
THOMAS: And this intersection of climate change and geopolitics is accelerating as well, so I think you and I are going to be working together for a long time.
THOMAS: So a topic as complex, deep, and rich as China, obviously has attracted the attention of lots of authors. And there are libraries of books on the subject, you and I both read plenty of them. What’s something you’ve read recently that you could recommend to this audience that helped you better understand China?
SANTIAGO:Well there are so many, Thomas. One that comes to mind, because it’s recent, and I thought it was very insightful, is called How China Escaped Shock Therapy, by an author named Isabella Weber. And the topic of this book is really understanding the difference between the Chinese development story and the post-Soviet development stories that were characterized by very rapid transitions, the so-called shocks therapy that frankly didn’t work. And what I like about this is that it takes a very open-minded view to the Chinese development model, where it highlights that this, if you call it crossing the river by feeling the stones type of approach, can actually have a lot of very positive results like we’ve seen. There are indeed challenges to this model looking forward, but I would recommend this book as a really insightful narrative of what has happened until now, and it opens up the question of obviously, where do we go from here?
THOMAS: All right Santiago, thank you so much for your time, your expertise, for everything you do for Wellington. It’s critically important.
SANTIAGO:Thank you for having me.
Views expressed are those of the speaker(s) and are subject to change. Other teams may hold different views and make different investment decisions. For professional/institutional investors only. Your capital may be at risk. Podcast produced May 2022.
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