China's Economy Has Reached A Tipping Point

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About: iShares China Large-Cap ETF (FXI), Includes: EWH, MCHI
by: Todd Royal

Summary

US trade war tensions are wrecking the Chinese economy.

European and Asian nations are after Chinese market share.

Global markets and international geopolitics are at stake.

The Tipping Point by Malcolm Gladwell asserts that, “Little Things Can Make a Big Difference.” This year small, innocuous events are building towards possible big changes for the Chinese government, it’s citizens, Southeast Asia and globally as well if geopolitical and economic events continue down this path. And with the United States (US) forging a new path confronting China – financial markets and geopolitics could be in for turbulence – that hasn’t been seen since the Cold War.

President Trump’s early October speech to the United Nations (UN) and Security Council where he accused the Chinese of, “attempting to tamper with US election,” and where Trump stated, “it’s not just Russia, it’s China and Russia” caused a stir at the UN. While the US media was fixated on the Judge Kavanaugh confirmations and burgeoning US-China trade tussle, the Trump administration is taking a harder stance against Chinese intelligence encroachments against US businesses. A report in early October from Bloomberg BusinessWeek exposed, “a sprawling multi-year investigation into China’s infiltration of US corporate and defense infrastructure.” The Report also:

“Confirmed that, in addition to efforts designed to sway US elections, China’s intelligence community orchestrated pervasive infiltration of servers used to power everything from MRI machines to drones used by the CIA and US army.”

The day before Trump’s UN address a 27-year old Taiwanese national in Chicago was arrested for attempting to turn eight; US defense contractors who could reveal, “sensitive defense-related technology.” Then in a first for US-China relations, Yanjun Xu, deputy division director for the Ministry of State Security (China’s main spy agency) was arrested in Belgium and extradited to the US where he will stand trial in open court for attempted, “stealing of trade secrets from companies including GE Aviation.” The New York Times asserted the arrest was, “a major escalation of the Trump administration’s effort to crack down on Chinese spying.” This could mean the US is leveling the global manufacturing field to earn the goodwill of global lower educated employees and blue-collar workers in emerging and mature markets. But this rankle Beijing where they have enjoyed a comparative trade advantage for decades that have lifted hundreds of millions of Chinese out of crippling poverty.

Columnist Walter Russell Mead in the Wall Street Journal wrote about Vice President Mike Pence’s speech to the Hudson Institute that Pence outlined a new “Cold War” against China. Pence denounced China’s, “whole of government,” approach with its rivalry against the US. Pence then blamed the Chinese of suppressing Tibetans and Uighurs, the “Made in China 2025 plan for technology supremacy, and using the Belt and Road initiative (BRI), as “debt diplomacy,” for economic enslavement. Pence, moreover:

“Detailed an integrated, cross-government strategy to counter what the administration considers Chinese military, economic, political and ideological aggressions.”

As bad as these issues are for global financial and geopolitical stability it’s internal Chinese discontent that should be causing greater concern. Highlighting the BRI’s destructive affects, Pakistan – one of the largest beneficiaries of BRI largess – has requested a bailout from the International Monetary Fund (IMF), “amid growing concerns that Beijing’s program is pushing recipient countries into financial crisis. The Pakistani’s are now being forced to court the Saudi's to avoid additional crippling Chinese debt associated with the BRI and, “pushing China to realign goals in its Belt-and-Road initiative.” Now Europeans and Asians have joined “Washington's fight against Beijing’s,” state-run capitalism model that uses BRI as a weapon against lesser countries like Sri Lanka, Pakistan and Malaysia. Free-market countries have a vested interested to block China’s ascendance and see real opportunities to gain market share from China. The “pushback” against China is real and ongoing.

China is also releasing over $175 billion of state credit to enhance commercial banks lending and pay down short-term borrowing debt. These actions are in response to the slowing economy resulting from the trade war escalating with US tariffs on $250 billion on Chinese goods and possibly taxing another $257 billion of products. To counter the US the People's Bank of China has lowered reserve requirements for many commercial banks by one percentage point effective October 15th. This is Beijing’s latest effort to assist their ailing economy.

The Financial Times reported:

“Chinese state-owned enterprises (SOE) have nationalized at least 10 privately owned groups this year, prompting warnings that the trend risks sucking the vitality out of China’s economy.”

Private groups in China instead of SOEs have suffered from Beijing’s push to eliminate, “debt and financial risk over the past 18 months upsetting the social and economic fabric of society that has enjoyed un-paralleled success since former President Deng’s “Four Modernizations,” program. But these actions also illustrate China’s unwillingness to allow open trad, and political freedom. Their recent actions in Hong Kong (a city in real trouble) by using the bullet train coupled with large infrastructure projects to tighten their grip and banning the city’s Pro-Independence Party demonstrate the Communist government is confronting serious issues.

Now Mexico, Canada, the EU, Japan, and the United Kingdom have all agreed under the revised NAFTA agreement and in separate negotiations with the US to “cut China out of trade deals with partners.” This new “pivot” means all countries have to notify the US before trade negotiations with a “non-market economy,” take place. This new NAFTA is a major setback to Beijing trying to co-opt the US-led post World War II liberal order for its Marxist-Capitalistic system. The world is confronting China using trade instead of guns for this new battle and if Beijing doesn't change course there is the real possibility of economic, cultural and political stagnation for decades ahead.

But what’s causing this new Cold War stance from Washington? As talks with North Korea falter and the South China Sea continues militarizing, Washington believes they are challenging China in preparation for the multilateral summit in November between Trump and Xi. And it seems to be working – from the Chinese economy’s overreliance on exports to Xi’s newfound respect for the US under Trump – the US is rewriting the global, geopolitical rules in a far-reaching campaign against Xi and Beijing.

However, what China understands about this US-led fight is the wide disconnect taking place in the US and its allies. China can still bully US allies at-will – evidenced by its recent deal with the Philippines – to control oil and gas resources in their waters. The US has incredible job growth and a booming economy but its political economy is fragmented and in tatters. But according to Foreign Affairs, “China's Return to Strongman Rule,” under Xi’s Presidency-for-life means badly needed reforms; political realignment and ending systemic corruption won’t be taking place in the near or distant future. Yet there is a striking dissonance and pessimism that fatigued western leaders and their countries don’t have the stomach for a new Cold War. What will win geopolitically is anyone’s guess when it comes to China versus the world with Trump at the forefront of this fight.

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.