Forensic Insights and Market Intelligence on Greater China
The chances of Hong Kong becoming a Police State in the months ahead is rising. Hong Kong equity markets will remain a shorting opportunity through much of 2020.
Violent protests have rocked Hong Kong for the past eight weeks, and judging by the intensity of the anger of the crowds and the lack of political response from the city’s leadership, the rage could go on for many more months, permanently destroying Hong Kong’s long-held status as a solid and stable global financial center and primary financial gateway of China.
All eyes will be on the meeting at the G20 meeting this week between US President Donald Trump and China’s President Xi Jinping. A lot is riding on the meeting as the markets are hoping that the two will somehow seek a détente, and all will go back to normal.
Looking at the official retail sales numbers, one would conclude that, even in the midst of a deepening trade war with the US, Chinese consumers remain confident and thus are spending more than what they spent last year. Yet, if we were to calculate the official numbers slightly differently, a disturbing picture of collapsing consumption emerges.
We are of the view that China is unlikely to devalue the yuan to below 7 to 1. However, what if the policymakers in Beijing saw few other ways to retaliate against higher US tariff rates and decide to use devaluation? In our view, Beijing will only seriously consider devaluation below 7 if the trade war led to net outflows of foreign exchange in the goods account. In that case, the technocrats likely will need to lay the groundwork to minimize the chance of an all-out panic, which will provide clear signs that China is preparing for crossing.
This past week, the financial market was mildly surprised by a public takeover of a city commercial bank, the Baoding Commercial Bank, by regulators from the People’s Bank of China and the China Banking and Insurance Regulatory Commission (CBIRC).
US President Donald Trump accelerated his attack on China by using what some have called the “nuclear option” by forbidding US technology companies from supplying Huawei Telecom last week.
Despite our sanguine attitude last week, we must admit that negotiations between China and the US have been delayed by an apparent backing out of existing agreements by China, followed by tariffs from both China and the US. The Chinese market reacted to the heightened tariffs immediately, losing 5 percent last week, followed by sell offs in the US market this week. Market participants are beginning to price in the possibility of a prolonged trade war, especially after a hardline China Central Television segment during the widely watched nightly news. So, is China digging in its heals for a prolonged trade war?
Despite the drama with Trump’s threats to increase tariff rates to 25 percent on $200 billion of Chinese export to the US, we still take the view that a final trade deal will emerge in the next month or two. We look beyond the immediate and analyze how the US and China may fare in the implementation phase of the agreement. Although we have not seen even a draft of the final agreement, we have seen discussion of some components of the agreement. Our analysis suggests that granting access to wholly owned foreign investors and financial sector opening have the greatest chance of being fully implemented, while China will not fully honor its agreement on purchasing goods from the US, lowering tariffs on US goods, and outlawing forced technology transfers.
For the US, a potential objective of the trade war in the past year might have been to shrink China’s trade surplus, which will make China’s entire economic model less sustainable. Yet, as we obtain the trade numbers from March, we see that China’s trade surplus in 1Q 2019 remained robust at US$75 billion, a whopping 50 percent increase from the first quarter of 2018. How did China do this in the midst of a trade war and visible shrinking of export to North America? In brief, China intensified export to Europe and Asia, shrank mechanical and electrical equipment import from Europe and Asia, and drastically reduced commodities import from the US.
The Party Central Administration Office (中办), the nerve center of the entire party, issued a new decree governing cadre evaluation and promotion, which will dictate the party’s human resource practices in the future. This is potentially an important change because many economists believe that the existing performance-based evaluation system for Chinese officials has been responsible for fostering competition between localities in China and high-speed growth in China in the past 30 years. Other scholars have credited the performance-based system for causing major catastrophes and human rights violations such as the Great Leap Famine (1958-1961) and draconian enforcement of China’s one-child policy.
Global investors certainly are waiting with anticipation the outcome of the Sino-U.S. trade talks and whether the two sides can reach an agreement and avoid an escalation of the conflict.
Echoes are coming out of Washington these days that the draft agreement being considered includes an addendum that will guide US dollar-yuan exchange rates going into the future, something akin to The Plaza Accords of 1985 signed between the U.S., and its then major trading partners, Japan, Germany, UK and France.