Autocrats, Bloodbaths, and Shareholder Value

The more aggressive the narrative control, the less credible the leadership

TAL Ed has lost almost 75% of its market cap (about $14B) since June 23.

Not sure if you noticed, but Chinese equities lost something close to $1 trillion in value over the last few weeks. Again, if you’re not aware, ONE TRILLION DOLLARS is a lot of dollars.

That’s quite some cliff. New Oriental lost almost 70% of its market cap (about $5B) in one day (June 23).

This loss was almost entirely due to the Chinese Communist Party’s rather erratic maneuvers that, in the case of ed-tech companies, actually made most (or sometimes all) of their business illegal.

This was entirely predictable.

Here’s the comprehensive list of things the Chinese Communist Party cares about:

1. The Chinese Communist Party

Here’s the comprehensive list of things the Chinese Communist Party does not care about:

1. Everything else.

It’s amazing that people have debates about social inequality or data privacy and control or population and demographic imbalances when it comes to the CCP’s decisions; any of those may be an issue but only as a result of the only thing the CCP cares about (again, that’s the CCP).

“I’m so rumbly in my tumbly.”*

It gets worse. “The CCP” isn’t even really the party; it’s Xi Jinping. But the issue is even more parochial than that. Xi’s sole governing purpose is to ensure the perpetuation of his power; of course, he needs the party to do that. But he swipes out his rivals as needed, and he’s got no greater rival than Jiang Zemin and his faction (Jiang Zemin led the CCP until 2002 and is still alive at 94.) Whenever a random company is blind-sided by some pseudo-populist regulatory agency, check the investors and see if one of Jiang Zemin’s partisans are involved (they will be). Xi Jinping spends his waking hours figuring out how to imprison and impoverish Jiang’s posse.

Dictatorships are Fundamentally Different

In the middle of the China ed-tech goldrush a few years ago, I was the wet rag. Investing in China posed enormous risks but investing in Chinese education could not possibly end well without a quick exit plan. When I said that, a group of VIPKid investors told me the IPO was “only” 2–3 years away. It seemed like an oddly risky way to bet a few hundred million.

VIPKid, which raised $1.1B from VCs, announced that it’s closing its core business. Source: internal email.

The first reason that any investment in China is high-risk is that Chinese firms have no incentive or requirement to conform to U.S. (or generally globally accepted) accounting practices. Never once — not once — has a Chinese court or regulator enforced GAAP-like accounting on a Chinese firm. If a company in China wants to go full Enron on you, there’s nothing you can do. Of course, this creates all sorts of moral hazard as the incentives for fraud run high.

The second reason is that there’s no incentive in authoritarian governments to report smaller problems. Small problems get swept under the rug because anyone who discovers a problem inevitably gets blamed for it. What authoritarian governments lack in meritocracy they make for in nepotism, graft and pervasive incompetence.

The result is that problems usually don’t reach a decision-maker until they are undeniable and enormous. We’ve seen this throughout CCP history. In the years leading up to the ed-tech gold-rush, sudden draconian regulations for urban motorcycles, peer-to-peer lending, street vendors, and other issues make clear that the CCP does not regulate incrementally, as democracies do. Instead, the problem metastasizes into an urgent emergency, and drastic actions follow, often without warning. One day, you and a million other residents of a city go to work on your motorcycle. The next day, they’re illegal.

The third — and most serious reason — not to have invested in the Chinese education sector is that authoritarian regimes will never share the mechanisms of narrative control. Democratic governments function due to the basic credibility that they acquire by being elected by the people. In other words: the people may think their government is incompetent, but they voted for it. Incompetent government is mitigated by the shared culpability of the incompetent electorate that voted of the government. (At the risk of stating the obvious, investments in Chinese media companies are actually dumber than in education companies. Predictably, the CCP is banning those too.)

Shanghai Dept. of Education notice ceasing English instruction for elementary school students and replacing it with Xi’s 14 thoughts.

Of course, voters can vote the government out at the next election. Authoritarian regimes have no such basic credibility. Rather, authoritarian regimes — and particularly communist regimes — have two credibility mechanisms. First, the regime will kill those who oppose it. Every communist regime has exhibited this feature in large part because Lenin established it as a basic feature of governance. (When governments say they are “Marxist-Leninist,” the “Leninist” part means that they implement arbitrary terror as the basis of Leninist rule.) The policy of arbitrary terror to establish and assert the supremacy of state power explains why purges of “good” Marxists occur in Marxist governments; for Lenin, ideology itself is a threat to state power, so sometimes those who are “too ideological” must be purged to demonstrate the supremacy of state power.

Probably China’s largest English language company starting shutting down a week after the June 22nd announcement. English language instruction is being stopped in Shanghai schools and replaced with “Xi Jinping Thought” (seriously, there’s a book and app of his thoughts; curiously, he has only 14 thoughts). Source: https://www.shine.cn/news/metro/2108133542/

Second, the regime must constantly assert its competence (“I know we seized power and none of you really asked for this, but didn’t we improve things?”). Authoritarian regimes are aggressive and inveterate propagandists because their basic credibility relies on the population believing that the regime is the optimal option. Importantly, the regimes often suggest that their “system of government” (i.e. communism) is superior when, in reality, these authoritarian regimes are government by specific people (or, a party), not by the system (e.g. communism). There exists no non-violent mechanism to replace the people (Xi) or the party (the CCP).

A trillion USD in losses is also too big to ignore.

Aggressive narrative control is the sign that a government (people/party) recognizes its basic credibility is questionable. Recently, the CCP blocked the ‘cake’ and ‘candle’ emojis on phones to prevent commemoration of the Tiananmen Square massacre in Hong Kong. This is evidence that the CCP is aware that people can (or likely do) question the basic credibility of the government.

Zhao Wei’s entire internet presence was scrubbed; her name was removed from all television series, films, short videos and promotional materials from platforms including Tencent Video, iQiyi and Youku. When feeling weak, the CCP’s narrative control is erratic and extreme; you really think they’re going to let foreigners teach their children? Source.

Regarding people/party: It’s important to remember that the government in China does not really run or own anything; the party does. China’s constitution is meaningless; only the CCP’s constitution — which is different from China’s constitution — matters. The military reports not to the government but to the party. And, technically and legally, the party owns the nation. Imagine if the U.S. Army was owned not by the Federal government but by the Republican Party. Imagine if all the real estate in America was not owned privately or by the Federal government but by the Democrat Party. Westerners usually don’t understand the weirdness of Chinese Communism — or, really, communism in general.

Increased narrative control is a sign of weakness; also, a sign that your investment is increasingly high-risk. Global Times is the CCP’s primary global propaganda vehicle. Source: https://www.globaltimes.cn/page/202108/1232364.shtml

There’s a saying that the bigger the monument, the more dubious the war (hello, Lincoln Memorial). Similarly, the more aggressive the narrative control, the less credible the leadership. When Xi Jinping is scared of Hong Kongers posting cake emojis on June 4th, he knows his credibility is weak.

The China ed-tech gold-rushers who required some semblance of regulatory reasonableness — as investors usually do — were always going to end up with tin. Economics may always be incentive-driven, but for Xi Jinping that motive isn’t profit; it’s the deification of Xi Jinping. (If you don’t see that as Xi’s endgame, then you haven’t been paying attention.)

Anyone who’s studied the CCP knows that the CCP doesn’t care about China. Mao openly detested his own people, and Xi carries on the tradition. All Xi Jinping cares about is Xi Jinping. He only cares about the party and others as is necessary to deify himself. (The story: https://tfipost.com/2020/05/xi-jinping-will-go-down-in-the-history-as-the-man-who-destroyed-china/)

* “I’m so rumbly in my tumbly.” One of Xi’s “14 thoughts,” on which Chinese school-children are trained and adults are quizzed (there’s an app you’re required to use every day), is that the reforms of his predecessors must be undone. Did any investor actually read this? He literally published a book saying he’s going to screw you. It’s Mein Kampf, Part 2.