Trump, Twitter And The CNY

| About: iShares China (FXI)
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Summary

Trump brings the promise of stronger domestic growth but also risk.

His tendency to lash out on Twitter is something of a joke, but brings risks.

Markets will focus on the China relationship and the CNY as one of the main sensitives.

Due to my generally quite constructive stance on U.S. Banks after Trump's victory I've been asked by a number of people about where I see the risks with Trump, and how they might be offset.

It's a good question and I see plenty of risks.

At this stage of course we are all trying to read the tea leaves of appointments and the President elect's Twitter (NYSE:TWTR) pronouncements. Hard policy is months away.

Presently my greatest concern is Trump's relationship with China and his twitter storm last night is a good starting point. As we know, Trump received a courtesy call from the President of Taiwan, which breaks with the practice established in 1979 whereby the U.S. supports Taiwan with military equipment sales but does not conduct formal diplomatic relations with it, which allows China to save face over what it sees as a breakaway province. After defending his Taiwan call, Trump unleashed against China on Twitter:

"Did China ask us if it was OK to devalue their currency (making it hard for our companies to compete), heavily tax our products going into their country (the US doesn't tax them) or to build a massive military complex in the middle of the South China Sea?" he asked. "I don't think so!"

Chinese currency policy has been a rhetorical football in the U.S. for a long time. Whatever the situation in the past, there are now good reasons for the CNY to lose value, as this is what you would expect from a country in need of deep supply side reform. Just as importantly, Trump's domestic policy proposals promise to raise growth and inflation for a period and therefore change interest rate differentials in favor of the US$ (which of course it already has done). If Trump aims to offset the natural currency consequences of his domestic economic policy by framing it as currency manipulation by China, he will at some point seriously alienate the Chinese leadership.

China is facing a near intractable debt problem having once again provided a massive credit stimulus to its economy. While consumption continues to grow well, this in part reflects the credit stimulus that sustains the financing chains holding together the increasingly dysfunctional industrial-financial complex there. Given these problems, the Chinese leadership is vulnerable as the Communist Party's legitimacy depends on providing rising living standards to the populace, and policy has generally moved in an authoritarian direction under Xi Jinping. While I have a lot of time for Michael Pettis' view that this may reflect an accumulation of power levers with which to "break" vested interests over structural reforms, the situation is opaque for observers.

Under these circumstances, there has to be a serious risk that any perceived or real anti-China rhetoric or perceived impending action by Trump could push Beijing into a more assertive nationalist stance in terms of domestic rhetoric and militarily towards the rest of Asia. We've seen this in Vladimir Putin's employment of strident Russian nationalism and military assertion to offset the ravages of a deep recession in Russia's economy and it structurally very low growth prospects. Short term, there is also a risk that the Chinese let the CNY go more aggressively before Trump takes office so that a lower CNY (see the chart below) is a fait accompli when he first sits down in the Oval.

Source: Bloomberg

There are obvious linkages between Trump's language on the CNY and his just repeated threat to impose a 35% tariff on US companies that import output from their factories in foreign economies. My sense is markets do not take these statements by Trump literally but if we think back to what a combination of falling oil and Chinese data and CNY weakness did to equity markets (and bank stocks!) earlier this year, we are reminded of the potential for Trump's approach so far to trigger similar market episodes in the future.

A money neutral long-short position in US domestic equities vs. emerging market and Chinese equities makes sense at least until we see enactment of convincing structural reform in China and/or gain confidence on the rhetorical relationship and CNY/US$ dynamics.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.