Davos Preview: Chinese Strategic Weakness Meets American Strategic Weakness

by: Adam Whitehead

President Xi Jinping is tightening rather than relaxing his domestic grip.

President Xi’s focus on control of the PLA signals his strategic weakness.

The domestic economy has still not sustainably rebalanced away from government supported to consumption led growth.

China has exposed American strategic weakness.

America and China may be aiming for a comprehensive bilateral trade deal.

The thesis of the last report alleged China's pivot from a domestic political orientation towards a global one. The global interface was presented as China's Belt and Road initiative. Vice Premier Zhang Gaoli recently gave further support to this thesis when he called for greater effort in this endeavor. Chinese intentions and capabilities have been understood and the pivot has stimulated a proportionate opposing global reaction. All roads lead to Davos for a further test of the thesis. President Trump's attendance at the event with a strong bench of officials should ensure a robust test.

A pre-requisite for a smooth transition was suggested as a stable economic footing. Premier Li Keqiang recently alluded to said stable economic footing, thus supporting the pivot thesis, with his comment that Chinese GDP is growing circa 6.9%; comfortably at the high end of the officially forecast range.

Perhaps President Xi Jinping does not yet feel that his domestic political footing has been fully secured enough in order for him to pivot with strength. In a recent speech, he called for further efforts to remove graft in order to "fundamentally improve the political ecosystem of the Party." It is thus no coincidence therefore, that China sources believe that a Constitutional amendment is currently being drafted.

Allegedly this amendment will strengthen the President's hand even further to suppress any lingering political resistance, under the cover of tighter anti-corruption laws. The threat may of course be exaggerated in order to provide him with total control, by portraying a system still requiring further reform. Consolidation and concentration of power is thus achieved by preventing any residual resistance. Whatever the cause, Xi's domestic political consolidation campaign is being ratcheted up this year.

President Xi Jiping's New Year's address to the PLA, effectively signaled his desire absolute military control. It is the first time that a President has effectively addressed the Chinese military as their individual commander in chief rather than through the agency of the Communist Party. Viewed through lens of President Xi's effective assumption of control of the Communist Party late last year, this combined seizure of leadership of the party and the military is the coup de grace.

Very recently, there has been a further move to imprison corrupt officers in the PLA. Putting two and two together, in order to speculate a little, it would seem that the further amending of constitutional power may be aimed at consolidating control of the PLA into President Xi's hands. Coup plotters may be real or even imagined in order to enable this consolidation.

The important conclusion from this speculation is that, until reform and restructuring of the PLA is complete, China's military threat is not as great as imagined or projected as being by those who have an interest in hyping it up. China remains strategically vulnerable from a military perspective. It is therefore not in a position to deliver on the threats that it projects against either its neighbors or America, in order to extract political and economic concessions from them. Politically therefore, China is still strategically weak and possibly more so than has been imagined, based on the recent attempts at further consolidation of power in President Xi's hands.

(Source: Bloomberg)

On the domestic economic front, perceptions of stability and sustainability are emerging. Observers note that China is getting more GDP per capita credit buck than it has done in previous credit cycles. This is fostering the opinion that domestic consumption has finally starting to do some economic heavy lifting, thereby taking the pressure off the government to stimulate economic growth. It also supports the view that policy makers can continue to mothball inefficient and wasteful economic capacity through structural reform at an accelerated pace. So much for perceptions, the reality is somewhat less rosy however.

(Source: CFR)

There is also little evidence that, despite the positive rhetoric and headlines, deleverage is actively being enforced in the state enterprise sector. The indebtedness of this sector continues to increase. Since official growth numbers have fallen, continued expansion of credit to this sector can only be seen as social policy to maintain harmony. Congruent with this wealth distribution scheme thesis, the PBoC also recently announced that it will be increasing credit to the poorest sectors in society.

(Source: Econoday)

The slow decay rate in retail sales has accelerated this month. This suggests that the re-balancing of the economy towards consumption, as the main economic driver, has still not kicked into gear yet. Further subsidies and wealth transfers to maintain the situation whilst nudging this desired consumption engine along can be expected in 2018.

(Source: Seeking Alpha)

Turning to the global interface with China's pivot, friction is rapidly developing; but there are also signs of cooperative lubrication if China pivots on global terms rather than its own. China's carrot and stick approach to global relations has been met with a growing global carrot and stick. A proportionate escalation of hostilities can be discerned unfolding at the global level. The hostilities were ostensibly triggered by President Xi Jiping's New Year's address to the military.

India's response was subjectively proportionate and without a carrot, as befits an immediate neighbor who feels threatened by a noisy neighbor. The world's largest democracy joined the elite club of developed nations, who have nuclear capable ICBM's with a range beyond three thousand kilometers. China is now well within range of India's nuclear stick.

America's military response was measured if not altogether proportionate. The last report noted that the Pentagon intends to make its nuclear arsenal more "usable". Further color about what "usable" is was recently leaked. Evidently, if one is to take this leak at face value "usable" means a new arsenal of low-yield nuclear weapons that can be delivered from the sea. Tactical Nukes and the threat of limited assured nuclear destruction ((LAND)) can now be added to the book of popular nuclear acronyms. LAND may not be as destructive as MAD, but its introduction into the mix has resulted in an escalation of hostilities just short of total global carnage.

The February 2016 article in this series suggested that President Xi was becoming a Czar. It is now fair to say that he has become one. It is interesting to note that back then his coup de grace was proselytized, in his own written guide for the perplexed, as being predicated upon the defeat of a counter coup. This theme has been central to and a catalyst throughout his ascent to ultimate power. It is therefore logical to assume that, in order to retain power, this ever present threat must be projected by him. He is becoming defined by his alleged enemies. The question now is whether this threat from within will be linked to foreign governments in order to perpetuate the control narrative. Czar's historically build empires through conquest. President Xi's pivot from domestic to global priorities, should therefore be scrutinized for imperial intentions.

The last report suggested that China's Belt and Road initiative would be the primary global interface for the nation going forward. Yin Yong, the Vice Governor of the PBoC recently used this frame of reference to promote the Yuan's use in international trade. According to him: "the Yuan's international status is far lower than the proportion of the Chinese economy in the global economy, which means enormous room for improvement in the currency's global use" and "In 55 countries along the Belt and Road, payment in yuan only makes up less than 5 percent of total trade volume." In addition to promoting Chinese exports of capital and goods, the Belt and Road is therefore also viewed as medium through which the Yuan can become a significant reserve currency. It is the medium by which the Chinese capital account will be fully opened up. So far China is creating a separate road to full convertibility, which it has some degree of control over. In response the established Globalist economic order is creating junctions under its own control with this separate road in order to contain and then encourage China to link up under the existing established rules. The game of carrot and stick thus complements a related game of snakes and ladders. These games are now being played with consummate skill on both sides.

(Source: Wall Street Journal)

The Trump administration took a further step towards imposing tariffs on Chinese Aluminium imports, after the US trade tribunal ruled that they are unfairly hurting domestic producers. Subjectively choosing the subject of Ant Financial's failed takeover bid for Money Gram International, Chinese commerce secretary Gao Feng bemoaned the rejection of the suit on national security grounds. Secretary Gao then went on to imply that this is a form of crypto-protectionism which China views as unfair. This was just the beginning of the skirmishing in the technology sector.

President Trump then turned up the heat in a televised interview, in which he warned that a big fine is coming for China having illegally coerced technology transfers out of American companies in return for business opportunities. As his attendance at Davos approaches, he is ratcheting up the pressure on China and expectations for a confrontation. There is also the possibility that he is just gaming the situation, in order to have a strong hand to play in any discussions; after the brinkmanship on both sides has escalated to a point at which rational negotiation occurs.

(Source: Gallup)

Evidently American policy makers see the invisible hand of President Xi Jinping in its global technological expansion. China will thus be asked to reciprocate, by opening its own sensitive communications and IT infrastructure to foreign investors, if it intends to play in this space in developed global markets. Global policy makers may however be overstating the threats from China. There is growing evidence that such threats are already being mitigated through cooperation at the regulatory and company levels. Since America is out of the TPP, a unique bilateral trade deal between the two nations is being set up. China has shown its preference to divide and conquer rather than engage in multilateral trade deals, unless they are on Chinese terms, so there is no real obstacle to such a deal in principle.

If President Trump were to achieve a bilateral trade deal, this could be Tweeted and accepted as a success based on the current skewed nature of trade relations in China's favor.

A precedent for a desirable symbiotic bilateral trade negotiation outcome already exists, so it should not be difficult achieve on a broader scale going forward. Alphabet Inc has recently entered into a joint global patent sharing agreement with Tencent. The agreement standardizes intellectual property standards in a way that leads to global competition for said standardized markets. Such a model is in the interest of both countries and their companies.

The growing adversarial rhetoric, at the political level between both nations, thus overshadows the growing cooperation at the commercial level. Faced with this commercial perspective, the rhetoric and adversarial posturing of the two political leaders should not be over-emphasized.

(Source: Fashion United)

A precedent and trading system has also been jointly set up to address the twin issues of supply chain transparency and environmental standards between China and its trade partners. This "Green Supply Chain Map" is the product of cooperation and collaboration between the U.S. Natural Resources Defense Council (NRDC) and the Institute of Public & Environmental Affairs (IPE) in China.

The IP protocols and transparency involved in both precedents can be viewed as essential components of bilateral free trade deal between China and America. The fact that they already exist implies that formalizing a trade deal could be a lot easier than many assume.

It should be noted that transparency and standardization is in the interest of China's industrial base, as it stimulates trade and investment. Despite the grandstanding of Chinese politicians, global (and American) standards of governance and information sharing are being adopted by default. Overlaying the creation of a collaborative and cooperative global trading infrastructure, there however still remain the headline big picture political challenges that are exploited to promote national interests and the interests of the politicians who promote them. These pursuits can however be addressed, to the politicians' satisfaction, through the current media outlets and forums such as Davos.

Under this precedent China is still however playing by global rules and not its own, which is a signal of strategic weakness and capitulation in as much as it is a practical necessity. China does not make the global rules of commerce, which are so critical to its survival. These rules were set down by America at the end of World War II and have been refined over the years in favor of those who have been its allies. China would be wise not to be seen as too much of an adversary and threat to these flexible rules of global alliance. China should however take and be given credit for focusing American attention above all else, so that it has been forced to adopt bi-lateralism instead of multi-lateralism. This is a significant strategic victory for China, despite its own strategic weakness. An American vulnerability has been identified and exploited….. or perhaps the world is just too big and complicated for Pax Americana these days.

On the Japanese maritime front, a politically inspired book about the alleged "Tragedy of Xi Jinping" was released to much regional acclaim. One of the tragedies is alleged to be Xi's strategic defeat at the hands of Prime Minister Abe's successful diplomatic encirclement, which supposedly prevented Chinese annexation of the Senkaku Islands in 2013. The adduced strategic defeat translated into President Xi's failure to use this territorial victory as a platform to build further national prestige for the nation and himself by default.

Speaking for the current globalist trade architecture and its continued embrace of free trade, IMF number two David Lipton politely criticized China for its hypocrisy; in supporting free trade that boost Chinese exports whilst not reciprocating by the same degree in relation to its imports from trade partners. Lipton also opined in relation to China's own domestic policies, that now would be a good time to use strength in the global economy to implement structural economic reform at home. Indirectly referencing the continued financial support of the state owned sector, he noted that deleverage and the application of market forces rather than political ones to allocate capital would also be advisable. China's intentions to pivot globally have evidently been spotted by the IMF and it is attaching its own conditions to address the situation.

Initially in reaction to the perceived protectionist attacks, China responded in tit for tat fashion by increasing the vigor with which it polices global companies operating within its borders.

China reacted sternly to its exclusion from the 20 nation summit hosted in Canada to discuss the North Korea situation. Chinese commentators portrayed this gathering as some kind of extended Cold War relic.

The Cyber Administration Office in Shanghai officially rebuked Zara for recognizing Taiwan as a separate country on its website. On the same day, China's Civil Aviation Administration officially rebuked Delta Airlines for the same transgression plus the recognition of Tibet. The companies were asked to change the "illegal" contents of their websites that listed Tibet and Taiwan. Marriott Group was also shaken down for its website references to Tibet and for having copies of a book that refers to persecution of Falon Gong by Chinese authorities in its mainland hotels.

With money at stake, Marriott capitulated swiftly. The Marriott capitulation, illustrates how China will use economic muscle to leverage up its less developed political muscle globally wherever and whenever it can. President Trump's signal that he will cite coercion and apply fines, in response to China's leverage strategy, signal that he is less malleable to financial coercion.

President Xi Jinping has tried to appear to elevate himself above the base squabbling between the major protagonists. In doing so, he revealed his own strategy and tactics. From the moral high ground, that he rhetorically constructed for himself, he reached out to President Trump and called on him to negotiate a solution to the current problems. Such a discussion would be perceived globally and domestically as a meeting of equals. It would also be inferred as a strategic defeat for America, similar to the humiliating 1973 Paris Peace treaty that ended the Vietnam War. Davos 2018 would then become the new Paris 1973. The price of President Trump's desired bilateral deal is therefore a high one to pay in political prestige terms.

President Xi has also shown that he inflames conflicts in order to bring his enemies to the negotiating table. President Xi has framed perceptions of him as defender of free trade and President Trump as a protectionist. President Trump therefore needs to debunk this myth and show that President Xi's free trade embrace is a charade that promotes Chinese interests to the detriment of all others. The cost of his bilateral trade deal could then be recouped to some degree.

President Xi's outreach is thus a signal that he is highly motivated to achieve a negotiated agreement on all issues with America, rather than to engage in a further war of attrition. He is also less confident that China will converge on and then transcend America economically at its current pace of development. The hard phase of this convergence process still lies ahead and President Xi therefore wishes to consolidate what has been achieved so far, rather than risk it on another protracted long march in the face of global protectionist forces. President Trump according to Ray Dalio is an enigma to Chinese policy makers. His behavior is thus not expected to be as pusillanimous as that of the Marriott Group, especially if the Trump hotel franchise is not directly threatened! President Trump has however shown himself to be someone who likes the Art of the Deal, so in principle engaged be engaged and negotiated with. In this case the deal is a bilateral trade one. The heads of terms now await negotiation, beginning at Davos.

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.