In case you haven’t noticed, there is an economic war brewing between China and the West.
This war started back in 2018 when the Trump administration imposed tariffs on China.
But it’s really started to heat up this year.
China’s handling of the spread of the coronavirus, which started in a Wuhan wet market or biomedical lab (take your pick) has been widely criticised.
Australia then led calls for an investigation into this handling. In response, China slapped tariffs on Australian barley and imports or meat.
In addition, it’s warned its students away from ‘racist’ Australia. Education is our third-largest export (after iron ore and coal). A great deal of the high fee paying international students come from China. It’s not an idle barb from the Middle Kingdom.
China is also fighting skirmishes (literally) on the Indian border. And it recently passed heavy-handed ‘national security’ legislation on Hong Kong. This ensures Hong Kong will now be more like China and less like the liberal democracy that has underwritten its economic prosperity.
Let’s go back to the Trump tariffs for a moment.
To get this analysis correct, you have to understand that TDS (Trump Derangement Syndrome) is more contagious than the coronavirus. That’s especially the case with the media and business commentators.
So most comments around this issue are, shall we say, infected with a bias that prevents rational thought.
Put simply, and without the bias, Trump’s tariffs are about making trade with China fair, not free. China, through labour and environmental exploitation, has a massive trade advantage with the West.
For years, politicians and multinationals have turned a blind eye to this because it has made them a lot of money. They have also turned a blind eye to China stealing valuable technology and intellectual capital.
But Trump comes in and says ‘enough’s enough’, and he gets ridiculed for it?
Anyway, that’s the backdrop.
Things are now heating up on the economic war front.
Taking the Economic War to Hong Kong
Last Thursday I wrote about the Hong Kong dollar peg, and how it was vulnerable to a China/US war. Yesterday, Bloomberg reported:
‘Some top advisers to President Donald Trump want the U.S. to undermine the Hong Kong dollar’s peg to the U.S. dollar as the administration considers options to punish China for recent moves to chip away at the former British colony’s political freedoms, according to people familiar with the matter.
‘The idea of striking against the Hong Kong dollar peg — perhaps by limiting the ability of Hong Kong banks to buy U.S. dollars — has been raised as part of broader discussions among advisers to Secretary of State Michael Pompeo and hasn’t been elevated to the senior levels of the White House, suggesting that it hasn’t gained serious traction yet, according to people who discussed the matter on condition of anonymity.’
This discussion of matters on the ‘condition of anonymity’ is how you put ideas into the narrative without taking concrete action. You sit back, assess the reaction, and go from there.
That this is a story is important. It means the US are looking at potential points of vulnerability.
In my view, they see China’s access to the US dollar as a particular point of vulnerability. China can only gain access to the US dollar via trade. It doesn’t have the luxury of a swap line with the Federal Reserve.
If, in a post-COVID world, global supply chains are restructured away from China, their US dollar earning capacity will suffer. This will put serious pressure on the yuan-US dollar peg.
Because China is manufacturing a yuan-denominated credit boom to claw its way out of the COVID hole. The ratio of yuan to dollars inside China is therefore growing.
But because China traps this yuan inside its borders (by imposing capital controls and a managed exchange rate), the pressure of this yuan credit growth is showing up in a rising stock market and other asset prices.
But how long until big money sees this yuan-dollar peg as too good to be true, and tries to get out?
What’s the best escape route to get access to US dollars?
Hence the Trump administration looking at bringing the economic war to Hong Kong.
Right now, mainstream investment analysts are not concerned about the Hong Kong dollar peg. Here’s one analyst response via Bloomberg:
‘It’s a fairly wacky idea that they would be able to force Hong Kong off the peg by some means. I’ve been against the idea that Kyle Bass and others trying to break the peg — that has been a spectacularly unsuccessful idea so far, and I expect it to be the same.’
Sure, right now, it’s a far-fetched idea. And the US is probably unlikely to make any drastic moves prior to the election in November.
But in six months, who knows what the impact of China’s draconian national security laws will be on capital draining out of Honkers.
In response to these laws, Scott Morrison yesterday suspended an extradition treaty between Australia and Hong Kong. He is also allowing existing Hong Kong residents and students in Australia to extend their stay, and will make it easier for residents to emigrate here for good.
China, not surprisingly for a regional bully, is not happy. Even Hong Kong, now China’s sidekick, blasted Australia’s removal of the extradition treaty. As The Australian reports:
‘The rare rebuke from the Lam government follows a barrage of criticism of Australia’s actions on Hong Kong by Beijing, beginning with an angry statement from the Chinese Embassy in Canberra “deploring” the suspension of extradition treaty and describing it as a “violation of international law….and a gross interference in China’s international affairs.”
‘This was followed by comments in Beijing by a spokesman for the Ministry of Foreign Affairs, Zhao Lijian, condemning Australia’s move and warning that China “reserved the right to make further reaction”.
‘“Australia should bear all the consequences,” he said.
‘Mr Zhao said China urged Australia to reverse its decision and “stop intervening in Hong Kong affairs and China’s domestic affairs and prevent further harm to China-Australia relations”.
‘He also called on Chinese students in Australia to take extra safety precautions and warned those students currently in China thinking of returning to Australia to “be cautious when making the decision to go or return to Australia”.’
This Aussie-China biffo is not going away folks.
And it’s going to have far-reaching implications for our economy and stock market.
More on that in the weeks ahead.