Hype of China technology stocks risks a replay of the 2000 US dotcom crash
Andy Xie says with so much money from both government and retail investors already sunk into a business that relies more on false hope than sound fundamentals, the pain of a crash will be severe. Can it be avoided?
After wobbling for a few weeks, tech stocks are dropping like in 2000. This is likely to be the beginning of the end for the biggest tech bubble in history. The US-China trade war, rising interest rates, and falling exchange rates appear to have finally staunched the liquidity inflow into the bubble.
And as in 2000, while the stock bloodbath could be over quickly, the economy would take years to recover from the economic fallout and financial damage inflicted.
Unlike in 2000, this tech bubble is bigger in China than in the United States. The current tech wave in the US is dominated by companies that have good cash flows. They are not gobbling up cash. Hence, the US tech burst will lead to reasonable valuations.
The expectation that these companies could keep growing rapidly is a pipe dream. Because they take business away from existing companies, rather than create new business, there is a cap on how big they can be.
Things will be different in China. China’s tech bubble is very similar to the US dotcom bubble in 2000. There are many companies being financed because they are doing something linked to technology. And, if they get revenue going, the market extrapolates it into infinity and gives them enormous valuations. Hence, they are encouraged to “buy” revenue through subsidies.
This means the bubble needs more and more cash to stay afloat. When there are lots of stupid people with lots of money, the game keeps going. But that kind of situation doesn’t last very long. As monetary tightening happens around the world, credulous people tend to lose access to money quickly.
The 2000 bubble was marked by many con jobs, just not on the scale of the WorldCom and Enron scandals. These tech companies misled investors with false expectations, even if they didn’t cook the books.
China today is in a very similar situation. The obvious example is the P2P (peer-to-peer) boom. It has been a blatant con job from the start. But there were so many credulous savers to be robbed. There was enough money sloshing around to entice both the government and media to join in.
Cryptocurrencies are another blatant example. There is enough evidence to show that they are a scam, and the market has plummeted lately. Yet the media is still hyping it, and not many governments are banning it outright.
China’s tech scene is full of semi con jobs. The main reason is government subsidies. In the past few years, local governments have been given the green light to pour money into tech. Suddenly, China has as many unicorns as the US.
Local governments are competing on how many unicorns they have. As in other areas, numbers can be massaged easily. A few guys sit around to decide the valuation of a start-up. When they say it’s a unicorn, it pleases their investors and the government.
Government support has greatly contributed to the bubble. There are dozens of automobile start-ups. China hasn’t got one competitive auto company at present. Why should the market believe that there could be dozens in the future? There are over 2,000 drone companies. Virtually every city is starting a tech park. In one park I visited, some 5,000 start-ups registered last year, mostly with their parents’ money.
As China’s A-share market has been collapsing, many are turning to Hong Kong to raise money or cash out. It is virtually the only hope. As US sentiment turns sour towards China, the Nasdaq isn’t likely to be friendly to Chinese “concept companies” – that is, companies that promise an innovative product or service but which look set for big losses as far as the eye can see. As Hong Kong is exposed to international turbulence, the recent developments seem to have weighed heavily.
It is possible that the Chinese government is directing funds to support the tech IPOs in Hong Kong. But, I doubt that it could mobilise enough money to do it alone. Beijing spends money to entice retail investors. Even in the politically sensitive A-share market, it hasn’t managed to keep the market stable. Even if government-directed funds help to launch a few initial public offerings, they will collapse afterwards, making them useless as funding vehicles over time.
China’s tech scene will resemble the US’ in the aftermath of the 2000 crash. Most dotcom companies folded, causing massive lay-offs and the loss of trillions of dollars in paper wealth. The Federal Reserve inflated a property bubble to rescue the economy, which led to the 2008 collapse.
In China’s case, the property market is already a massive bubble. It may burst soon. There are few obvious options for China to bring back economic growth.
The Chinese government has been obsessed with tech. The current bubble features companies that use the internet to take business away from existing companies; so-called “disruption”. Airlines use commercial jets, probably the most hi-tech equipment in the consumer market, to carry people from A to B. But we don’t call airline companies hi-tech. Using hi-tech equipment doesn’t make a company hi-tech. It is puzzling why the government has manoeuvred so many resources into a bubble that won’t have a meaningful legacy.
Only structural reforms can bring back good growth in China. Instead of wasting so much on pointless bubbles, China should go back to the fundamentals: cutting wasteful investment and returning the money to the people, while encouraging companies to be the best in what they do, instead of playing financial games.
Andy Xie is an independent economist