Tuesday, January 14, 2020

China Is Not Waiting For The Trade Issue To Be Resolved

China Hellbent On Becoming Leading Power!
China is not merely waiting for the trade issue with America to be resolved. China has a plan and is busy cutting a path forward with far more focus than is being displayed by America. Despite economic problems popping up in countries across the world, China is hellbent on pursuing its goal of galvanizing itself as the leading global power. The Chinese are actively pursuing a scheme to expand President Xi Jinping's continent-spanning One Belt One Road into new areas by promising loans and investments to countries across the world that are struggling economically. 

China has also been moving strongly into other areas of investment. For example, the Nikkei Asian Review recently reported that China is nearing completion of its new global positioning system (GPS) network. This is a sign of China's desire to dominate the world's next generation of telecommunications services and further decouple from the US' GPS network. China's Beidou network of satellites is expected to be completed in a few months when the last two of 35-satellites will be launched. Over 70% of Chinese smartphones are ready to tap into Beidou's positioning services. The system also plays a role in fifth-generation wireless communications, this is an area where China's Huawei Technologies is said to be leading in technological development.

The Beidou network of satellites is supposed to create a number of global services that benefit ASEAN, South Asia, Eastern Europe, West Asia, and Africa in precision farming, digital construction, and smart port application. By the end of next year, positioning accuracy is expected to improve from within 5 meters to within centimeters. This accuracy is crucial for self-driving vehicle development and seen as an advancement that will aid in search-and-rescue missions. Moving farther up the food chain is a core part of Beijing's "Made in China 2025" plan for boosting self-reliance in vital technologies. This is also apparent in an article I penned about the C-919Their new Chinese airplane is intended to compete directly against Boeing and Airbus.

This does not mean China has left its problems behind. It is important to remember that politicians, even those in China, tend to go to extreme efforts to avoid taking responsibility for the problems they create. History shows that one way a country can kick their gross domestic product higher is to build a false economy based on infrastructure or war. One of the best examples of building an economy on a foundation of military might or a massive move to militarization was demonstrated by how Germany was turned into a war machine during the 1930s. China's version of this has been apparent over the years in its bizarre housing market and "ghost cities" where 75% of its peoples' wealth is stored. The OBOR initiative and China's growing space program may be an extension of this idea.

One of the biggest challenges china has going forward is that, in some ways, the Chinese residential real estate market could be called the most overvalued asset class in the world. An article written in late 2018 details how much of China's so-called wealth is tied up in poorly constructed overpriced homes. The fact these have only gone up in value has created a Ponzi scheme of massive proportions. The excesses in China's real estate market have not yet been resolved and when they are it is very likely the process will be deflationary. The resolution of bad debts reduces the money supply and tends to put downward pressure on prices until the excess supply gets worked off. With estimates that as much as 75% of Chinese net worth is tied up in this market the contagion resulting from dropping prices will undoubtedly spill into other markets.

Debt Has Exploded In China (click to enlarge)
The point of this article is to focus on two things, where China wants to go and how it got to where it is. This includes the matter of its addition and dependence on new credit creation to drive its economy. Prior to 2008 money flowed into China as companies invested there but since then the inflow slowed to a trickle then reversed. Since then new credit and surging debt have become the new driver of growth. When a country gorges at the trough of deficit spending that generates a big temporary boost in its GDP it also quickly creates a wall of debt and this has been China's fate.

Despite Beijing's efforts to decouple from America and its progressive agenda, China's economy continues to slow. This has forced the Peoples Bank of China to undertake several major liquidity injections. Each time the PBOC does this global markets have moved higher because the money seeps out across China's border. Simply put, China's currency is much weaker than many people think when they point to China's large holdings of U.S. Treasuries as proof of its solvency. The fact is even though China owns these U.S. Treasuries, China is running a massive U.S. dollar shortage both on a corporate and a national level. A great deal of debt has grown within the Chinese system. Chinese companies owe roughly $2 trillion U.S. dollar-denominated debt owed to international investors.

Ironically, the Fed has become the great enabler in this game of allowing China's currency to hold together. China's rapid expansion of debt and credit during the last decade could not have occurred without the Fed being complicit. It has been the Fed that decided to allow the dollar to be used as a global prop. A key role of a reserve currency is to force other currencies to toe the line or pay a stiff price. Ignoring this economic reality translates into pain for those holding the currency of any country that abuses this economic law. The rubber will meet the road as more countries that export to China question the value of the Chinese currency and demand payment in dollars and refuse the yuan.

The power of fresh credit as a tool to propel growth forward in China has collapsed. Over the years each new wave of money has begun to lose its impact as the efficiency of stimulus waned and more and more of the credit was absorbed in supporting existing debt. The fact is few good investment opportunities currently exist in China which has caused more and more money to leak across the border inflating asset bubbles in other countries. In other words, injecting more credit into the economy is not the miracle solution it used to be. China needs a much larger expansion of credit than 10 years ago to have the exact same amount of GDP. This has caused an article in the  Global Times to speculate China is contemplating moving interest rates to zero in a desperate move to stimulate its economy. 

China's debt has become the biggest wildcard for the stability of the global financial system. Continuing along this "one-way path," in January, Beijing injected a staggering $685 billion in new credit into its financial system, greater than the GDP of the 21st largest country, Taiwan. China watchers, economists, and investors have been forming battle-lines for years as they debate the true strength and sustainability of China's economy and its role as a global player. Those of us that paint a picture of China's future collapse are often accused of spreading "doom-porn" when we claim the Chinese have masked over their dire situation by continually expanding credit. Those of us in this camp see China as continuing to prop up the unpropable, and yes, while no such word exists, when it comes to China's economy it should, for "unpropable" describes the financial collapse that can only be postponed but not stopped.

The "China discussion" is comprised of many threads. These range from concern over what is seen as its goal of world dominance to huge questions over China's true strength. Some people even think, we should or can simply "take them out." In a world jaded by propaganda and fake news, it is difficult to get your head around what is real. I stand with those that see China has little intention of altering its course. This means China will continue to concede little as trade talks drag on and their goal is to "wear-down the impatient Americans." Beijing and Washington have agreed to a tariff cease-fire as part of a "phase one" trade deal. Yesterday Bloomberg reported the U.S. would lift China's "currency manipulator" tag hours ahead of the Phase One trade deal signing. This coupled with talk the second part of this deal may not be implemented until 2025 shows America has no stomach for playing hardball. Expect more conflict ahead.

1 comment:

  1. I've been watching this for years and america is being outflanked and out smarted.China,at my last count,has signed trade and finance agreements with 30 countries,america has reneged on at least 5 ! My only concern with China is that some of the routes for their belt & road are through very volatile countries and I wonder how long it will be for them to have to deploy troops to defend them !!