China: You have to know the rules to play the game.

Here’s the deal: I am a trader, not an economist. I have no qualifications that would allow me to dig up any data that others don’t have or create innovative econometric models. What I am good at (I think) is coming up with trading strategies given an economic paradigm.

The USA has been my bread-and-butter for many years. Some find it challenging to operate in such transparent and well-researched market; they bemoan the lack of informational advantage. I am very happy with the lack of informational disadvantage. When it comes any broad domestic market, I can rely on widely available research to formulate my strategies. In fact, I don’t even have to read in-depth any particular research – a mere osmosis gives me sufficient idea of what is going in the United States. Following any given researcher closely accords more of this person’s opinions and little in a way of informational advantage.

This way of thinking has been leaving me in the dust when it came to China. The future of this country is one of the largest (if not THE largest) variables which will affect the course of global economy. And I have been at a loss of how to formulate a China strategy for over a decade. Any trade I could conceive of left me at a huge informational disadvantage.

The problem is dual. Any official statistic coming out of China is unreliable. But even if I had the correct numbers, I wouldn’t know how to interpret them: Chinese party-controlled society needn’t obey the same causality laws as a true free market economy.

The hodge-podge of conflicting opinions on social media was very confusing and I have been having hard time distinguishing between biases (including my own) and hard facts.

It was like playing poker without knowing the hand rankings.

This is why, I have so much looked forward to a comprehensive modern book on Chinese economics. Yes, modern. I didn’t need a review of the Ming Dynasty politics, but a systematic professional presentation on what is going on now.

John Mauldin and Worth Wray, the creators of the anthology A Great Leap Forward? didn’t disappoint. The editors, as well as their contributors, are not afraid to state their opinions, but what distinguishes this book is the intellectual discipline of separating those opinions from facts.

The anthology engages China sceptics and optimists to deliver every point of view to a reader.

China bears tend to focus on ballooning credit growth problem, mounting inefficiencies, and pressures on the RMB carry trade. Meanwhile, the bulls talk about the unique positioning of China, its potential to technologically leapfrog the West, and the government being on the right track to conducting the necessary reforms.

Yet the book’s discourse on China cannot be characterized as simply a battle between two opposing camps. The interaction of economic and geopolitical scenarios creates a non-linear set of outcomes. The contributors all realize the underlying uncertainty, but they assign different probabilities to various possible paths for China.

The styles of chapters are as diverse as opinions: some are very technical and some read like excerpts from a geopolitical thriller. Fortunately for a non-professional reader, the editors present a summary for every chapter, which allows one to decide where to focus their attention.

There was a bit of tough love for me. l did not finish this book with a clear plan or strategy imposed, rather I was given the facts and arguments and will have to come up with my own decisions. It is more daunting, but in the end, this is the way I prefer it.

Those who follow me may have noticed that my tendency is to side with China sceptics. I do have three inherent biases:

  • I am sceptic of any government being able to retain control, as they manage economic transitions.
  • I have very low respect for Communist ideology and the ability of Party to control corruption.
  • I have observed Chinese historical tendency to self-destruct each time they have risen to dominance.
  • A Great Leap Forward helped me to see past those biases and remember that

    • On one hand, the current positioning of China is truly unique and unprecedented.
    • On the other hand, there are examples of authoritarians rulers successfully implementing economic reforms (Pinochet’s Chile and Peter the Great’s Russia come to mind).

    The next step is to parse what I’ve read, discover undeniable common threads, and to find asymmetric macro bets.

    For example, the opinions on the imminent RMB devaluation range from near certainty to very low likelihood. But this is where I can get useful takeaways.

    Assume I believe the estimate of a China optimist and relative RMB bull that chances for this year are:

  • 75% no deval
  • 15% small deval
  • 10% large deval
  • An economist in my place would say “my forecast is no deval”. But as a trader I say “there might be limited downside, positive expectation bets on deval”.

    Or, when a contributors thinks that in the event of continued dollar appreciation RMB will deval slightly against the dollar, but perform well against other currencies, I say “Aha, I can have a low risk bet on strong dollar via shorting RMB”.

    So, I am still leaning toward the sceptics, not because I am certain they are right, but because they offer positive expectation bets that can have an additional benefit of protecting portfolios in the event of China-induced global slowdown.

    A Great Leap Forward is a must read for anyone whose financial fortunes are in any way linked to China (which is by now almost anyone).