A report of 8 April, 2018 by Capital Management Group (CMG) outlines strategic insights on US-China economic rivalry by Louis-Vincent Gave of Gavekal Reseach, leading to conclusions that China's bonds and other China plays seem a good bet.
The following bullet-point synopsis is enriched by drawing from related material for Gave's presentation Chinese Bond Market at the Hotel Metropole in Geneva on 15 June.
- The global deflationary era fueled by decades of China's expanding production capacity has come to an end.
- Unlike Reganeconomics, President Xi's supply-side reform means supply consolidation, reducing over-capacity and shifting the country's development towards innovation, technology, and greener, more sustainable, albeit slower growth.
- China's response to overcapacity encompasses innovative ways, e.g. shared bicycles, shared office space, and Airbnb, although these innovative ventures do not depend on overcapacity.
- President Trump's massive tax cuts and continued deficit spending call into question the long-term advisability of foreign investments in US treasuries and in the greenback. This compares with relative stability of the RMB, which is backed by more prudent, anti-inflationary monetary policies, driven in part by bitter memories of Tienanmen Square grievances.
- President Xi wants to restore China to ancient Asian dominance through more assertive foreign policies, including the Belt and Road Initiative. Thanks to China's global connectivity and status as the world's largest energy customer, the RMB is likely to gain popularity for international trade and as a reserve currency, potentially rivaling the greenback at least in the Asian region.
- Supported by gradual exchange rate and interest rate liberalization, China's RMB 5-year bond yield (+3.4%) consistently outperforms other government bonds, including US treasuries. China's government bonds are poised to join global bond benchmarks before long.
- As for "trade war" against China, President Trump said, "We don't have a trade war. We have already lost the trade war". The current frictions are symptomatic of more intense broad-based rivalry with China for power and influence, not just on trade, but on technology (Made in China 2015) and on currency dominance. Witness, for example, the Trump administration's planned restrictions of China's access to US cutting-edge technologies, including that by Chinese students in the United States.
- These frictions are forcing China to redouble efforts to open up financial and other market segments, not least its exploding consumer market. Thus RMB bonds, Chinese consumer, and Chinese financials among others are becoming attractive asset classes.
The above synopsis would benefit from the following additional perspectives -
- The relative attractiveness of RMB bonds is supported by a South China Morning Post article of 9 May China’s bond market is the unlikely winner of US-China trade spat. Here's how Additionally, a new era of rising interest rates is likely to tarnish any shine of US treasuries.
- According to a CNBC report of 2 February, China's currency is still nowhere near overtaking the dollar for global payments The report points out that just 1.61 % of domestic and cross-border payments processed in December 2017 were denominated in RMB, compared with some 40% represented by the greenback. In fact, RMB's global share fell from 2.31% in December 2015 to 1.68 % December 2016, thanks to tighter regulatory measures to stem money outflows. Nevertheless, the report acknowledges budding signs of international institutions warming up to the Chinese currency, including European central banks' decision to include it as a reserve currency, incorporation of Mainland shares in MSCI's Emerging Market Index, and, as of 26 March, China's launch of RMB-denominated oil futures.
- Should RMB's popularity achieve a sustained 10% annual rate of growth, perhaps through full capital account convertibility, its global penetration rate could be 32 times larger in 36 years, sufficient to usurp the dominance of the greenback by 2050 if not sooner.
- As for technology, a salutary example can be drawn from space exploration. The United States has been cooperating with Russia on human space flight programs for three decades but not with China. This has not prevented China from advancing its own successful manned and unmanned space programs. Indeed, Russia under US sanctions is now thinking of switching its cooperation to China. Click here So the Trump administration's anti-China science-and-technology access-denial tactics are unlikely to stop China from advancing, not least in developing its own high-tech chips embracing 5-G and artificial intelligence. Moreover, other advanced countries may not be as hostile as the US towards China's innovation, including research and development. The European Union is a case in point. A Chatham House research paper on this topic is instructive.
- Another changed dynamic is the Trump administration's attitude towards traditional allies, who are not exempt from "America First" economic coercion. Within the United States, a backlash from powerful pro-trade groups is already rising. Moreover, tearing up hard-won multinational agreements such as the Trans-Pacific Partnership (TPP) and the Paris Agreement on Climate Change has left allies disappointed and uncertain of the value of US partnership. Some, including Germany and Japan, are beginning to warm up to China if only as a hedge against an unpredictable if not untrustworthy Trump administration.
- Destined for War: Can America and China Escape Thucydides' Trap notwithstanding, the idea of an all-out war to thwart China's rise would be as inconceivable as it would be futile. First, such a move is prone to uncontrollable escalation to global nuclear Armageddon, triggering mutually assured destruction. Second, while public opinion in the United States has turned more negative towards China recently, this does not translate into widespread support for preemptive war to deny China's rise. Third, China's military has been advancing by leaps and bounds. This includes advanced A2/AD (anti-access/area denial) capabilities, not least of which are fortifications and deployment of hypersonic aircraft killer missiles on strategic islands in the South China Sea. Thus, a limited regional conventional war against China appears increasingly unsure of success. If anything, this may hand over a convenient pretext for China to take over Taiwan by force as a defensive measure.
- All in all, China's rise seems not a question of whether but how soon. And the lookout is more likely on how well China succeeds in responding to many domestic socioeconomic, ecological and political challenges rather than on some wishful thinking of preemption by military or economic coercion.
