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Global Investors Should Stop Bankrolling China’s Geopolitical Ambitions

investors in the U.S., New York Stock Exchange

International investors who have poured trillions of capital into the shares of Chinese companies have suffered their most significant loss since the 2008 economic crisis. Between Friday, July 23, and Monday, July 26, the Golden Dragon China Index plunged more than 15 percent. Other major stock indices focusing on China saw a similar decline, and many of them are now in the negative territory for the year. The culprit of such a massive loss is none other than the Chinese Communist Party (CCP).

The CCP launched a series of crackdowns on China’s largest technology firms, private education companies, and food-delivery companies in recent months. It all began with last November’s abrupt cancellation of Chinese tech giant Alibaba’s affiliate Ant Group’s $37 billion initial public offering after its founder Jack Ma criticized Chinese regulators in a conference. Ma hasn’t made many public appearances since then. Some suspect he is under house arrest. Investors inside and outside China were left to face losses worth billions.

This April, Chinese regulators imposed a $2.8 billion fine on Alibaba due to the government’s so-called “antitrust” investigation. That month, Chinese regulators summoned the 34 largest Chinese tech companies, including ByteDance, the parent company of popular app TikTok. They gave leaders of these companies more than 100 items of compliance, covering antitrust, data, advertisement, pricing, and more. After the meeting, all 34 tech companies issued similarly worded public statements, pledging to abide by the government’s antitrust laws and to assume more responsibilities to support China’s economic and social development. It was a total surrender.

Continued Crackdown

Chinese regulators passed a data security law in June. While the Chinese government claimed that the objective of the new law was to protect Chinese citizens’ privacy, in reality, the law solidifies the Chinese government’s access to all data that Chinese and multinational companies collect in China. The law became Chinese authorities’ new tool to continue cracking down on China’s tech companies and citizens.

After the Chinese ride-sharing company Didi was listed on the New York Stock Exchange with a $68 billion valuation, the Cyberspace Administration of China (CAC), a regulatory body that reports to the CCP’s leader Xi Jinping, accused the company of engaging in illegal collection and sharing of user data. In July, CAC ordered China’s app stores to remove Didi’s app and launched a cybersecurity investigation of Didi. The crackdown caused Didi’s stock price to drop more than 30 percent in recent weeks. The company is now facing a lawsuit from international shareholders.

But it turned out the CCP’s crackdown on some of China’s most successful companies had just begun. Last week, Bloomberg reported that the Chinese government announced new rules to rein in China’s after-school tutoring companies, including forcing them to become nonprofit organizations, limiting fees these companies can charge, and banning them from raising capital and obtaining foreign ownership. For China’s private tutoring industry, these new rules amount to a death sentence. New Oriental, one of the largest tutoring companies in China, saw the price of its Hong Kong-listed shares drop more than 80 percent in two days. A JPMorgan Chase & Co. analyst concluded that China’s new rules “make these stocks virtually un-investable.”

Bloomberg estimates that the Chinese government’s recent smackdown of China’s tech and education sectors has wiped out $1.5 trillion in value. Even investors who do not own these stocks directly likely suffered losses because many mutual funds hold these Chinese stocks in their investment portfolio. The speed of China’s policy change and the magnitude of the financial loss were unprecedented.

There are indications that the crackdown isn’t over yet. The Chinese government is reportedly taking its ax to the gaming, health care, and property sectors next.

Little Recourse for Global Investors

Unfortunately, global investors have little recourse to hold the CCP accountable and recoup their losses because of the type of shares of Chinese companies they own. Since Beijing bars foreigners from taking ownership in what it deems strategic sectors of the Chinese economy, many large Chinese companies created offshore holding companies or variable-interest entities (VIEs) to raise capital from foreign investors. Joseph Sternberg of the Wall Street Journal explains that owning shares of these VIEs is very different from owning normal stocks:

The Western investor doesn’t own anything, since ownership of the VIE does not translate into a claim on the assets of the operating Chinese company. The Western investor can make no demands on the management of the Chinese company because absent an equity stake there is no mechanism by which to influence or change management. In the event of a dispute, no one can guarantee a Chinese court would enforce the contracts binding the operating Chinese company to the VIE that Western shareholders do own.

In summary, these VIE shares offer foreign investors minimal legal rights or protections. But many investors downplayed these risks for years because they have bought the China growth story the CCP sold to them. China’s booming economy fooled global investors into believing the CCP is their best friend. No one had imagined that the CCP would be willing to destroy an entire industry with abrupt policy changes.

Why Did China Make Such Abrupt Changes?

There are several explanations for the CCP’s recent regulatory actions. First, some Chinese companies and their founders have become too powerful for the CCP leader Xi’s liking. As a dictator, Xi regarded any criticism as a threat to his power. So he suspended Ant Group’s public offering after Ant’s founder and largest owner Ma criticized Chinese regulators. Xi made Ma “disappear” to show Ma and other Chinese tycoons who is really in charge.

Second, the CCP, under Xi’s leadership, has shifted its priorities. Since the CCP launched economic reform in 1980, the CCP’s top priority for three decades was to grow the Chinese economy to remain in power. However, as Xi consolidated all power in his hands, he made it clear his priorities are national security and social stability, which he sees are crucial to keeping himself and the CCP in control.

Xi cracked down on tech companies so they would surrender the massive data they collected to the government and assist the government in controlling the Chinese people. Xi restrained private tutoring companies as a way to address China’s demographic crisis caused by the CCP’s brutal “one-child” policy. That crisis threatens economic growth, which in turn threatens the CCP’s rule. Some Chinese parents complain that the rising cost of education is one of the reasons why they do not want to have more children, so Xi hopes that reining in private education companies will lower that cost and thus increase the population.

Xi will sacrifice anyone, any business, or an entire sector if it serves his priorities.

Last, Xi, like his CCP predecessors, has treated capitalists and their money as nothing but tools to help the CCP achieve its economic and political goals. For decades, the CCP has relied on foreign investments to finance technological advancement and industrial development in China, hoping to return China to the dominant world power status.

But Xi also has very cynical views of capitalists. He regards them as people who have no ideology but are solely driven by greed. Therefore, Xi is confident that no matter how much he hurts them financially, capitalists won’t stop investing in China because the Chinese market is too enticing for them to give up. Xi can quickly point to those Western businesses that have kowtowed to him, such as Apple, Disney, and Nike, as sources of his confidence.

Xi clearly doesn’t care how much financial pain he has inflicted on global investors as long as he achieves his goals. It’s time that international investors finally learn their lesson that the CCP has never been their friend. They should stop financing the CCP’s geopolitical ambitions. A much better way for investors to achieve long-term financial growth is to invest in countries that rule by law and protect individual freedom and property rights.