I’ve noted before in this blog that I think the impending Cold War between China and the US is THE TREND to watch out for in the next decade. I’m usually on the most hawkish side of every national security debate but on this, I find myself much more conflicted. I think the Chinese have made a huge mistake in their tactics around building a competitive advantage. They must have realized that their excessive theft and cybercrime would rebound hugely on their relationships with external players. It was, I think, a brazen example of a political leadership allowing front line operatives to make their own decisions. The Chinese simply cannot ignore the reality that they’ve NOT been playing by the rules, and that blowback was to be expected.
But I’m also equally suspicious of the John Birch Society-like stereotyping of the Chinese communists as the New Enemy. Sure, they may be a challenge but pushing them into a containment corner and encouraging a bifurcation of global trade is an asinine reaction to a strategic threat. It needs calibrating and ultimately a proper sit-down negotiation before the hard men of the military take charge.
Anyway, in the meantime, we have to navigate our way around the existing conflict, over trade and tariffs.
I’ve been looking for a good summary and last week I got a brilliant one from a team of analysts at Barclays, who to date have been spot on. The team is led by Jian Chang and their paper from last week is worth quoting at length. The key takeaway is that these analysts think it is “unlikely [China will] make further concessions unless the US offers compromises”. This means that their Standoff scenario is “materializing and the Escalation scenario is becoming increasingly likely”. The Barclays authors think the Chinese position us best summarised by quotes from Hu Xijin, editor-in-chief of China’s Global Times. These quotes include:
- (18 May) “China will certainly retaliate for the barbaric suppression Huawei received. It’s a unanimous attitude of officials and ordinary people. I believe Beijing is selecting retaliation targets and approaches, minimizing damage to itself, and not weakening confidence in China’s opening up.”
- (18 May) “Trump delays EU, Japan auto tariffs for 6 months since there is little chance of reaching a China-US trade deal in six months. The two sides have serious differences with the worsening political atmosphere. Negotiation terms have been laid bare to the public, making compromise difficult.”
- (20 May) “The US is dealing with China with a new kind of cold war, out of a deep sense of crisis in its insufficient economic competitiveness.”
- (20 May) “The US cutting off Huawei supplies completely woke up Chinese society. China will face difficulties in the short term. We will devote to independent R&D and abandon any illusion. But it is also a real turning point of the US semiconductor companies gradually losing the Chinese market.”
- (22 May) “China is now reassured and ready for a protracted trade war. The political goal of not yielding to the US has been placed above the economic goal of minimizing losses.”
So, what might the next steps be for China? According to the Barclays analysts, the official rhetoric has hinted that some non-tariff retaliation could be imposed, which could include “intensifying shipping inspections and prolonging customs checks, applying greater scrutiny or delaying approvals of licenses and permissions for doing business in China, and tightening regulatory discretion of investment by US companies. Citing a recent survey, the American Chamber of Commerce of China said this week that nearly half of its members are seeing non-tariff barrier retaliation in China as a result of the increasingly bitter trade war (“U.S. business group says retaliation rising in China amid trade war,” Reuters, 22 May). The survey also suggested that 40.7% of respondents were considering or had relocated manufacturing facilities outside China, which increased from 19% from the survey before the latest tariff hikes”. Other measures could include:
- Export restrictions: Limiting exports to the US of some critical resources such as rare earths. President Xi’s visit to one of China’s major rare earth mining and processing facilities adds to the possibility of banning rare earth exports, as China did to Japan in 2010.
- Restrictions on sales of US goods and services: Restricting sales of certain US products and services in China, based on national security concerns or for regulatory or legal violations etc. The restrictions could apply to US smartphones, servers, autos, pharmaceuticals, or distribution of Hollywood movies and series, as long as the action would not incur significant domestic economic and employment costs. For example, the recent legal case filed by Chinese airlines with Boeing could be viewed as a move in this direction.
- Financial tools such as devaluing CNY and selling off US treasuries. We think in the event of further escalation of the tariff war, China would allow measured weakness in CNY, although we think the Chinese authorities would be unlikely to tolerate a very sharp and sudden depreciation (Thinking Macro: A Q&A on US-China tensions, 15 May). It is interesting to note that while Reuters reported that “China’s central bank will not let yuan decline past 7 to the dollar” on 17 May, the time horizon initially reported was “in the immediate term,” which was revised in a later version to “in the near term.”
- Other non-tariff restrictions targeting US companies trading with or operating in China. The Xinhua commentary (“Triumph will be in China’s hands,” Xinhua, 21 May) said “China has demonstrated full readiness to fight back,” highlighting “there are many possible options given the inter-dependency of the two economies” and that “China is not bluffing.”
- Imposing restrictions on travel to the US. The US services trade surplus (mainly in the travel, intellectual property categories) with China was USD40bn in 2018.
- Delaying or canceling official and civil exchanges and visits between the two countries, likely through tightening approvals and visa requirements etc. (“China recalls giant pandas from US zoo amid the ongoing trade war between countries,” Mirror, 17 May)
In domestic terms, the next measures might include :
- Indigenous innovation: During this week’s tour in Jiangxi, President Xi stressed the need for self-reliance and emphasized that “technological innovation is the root of life for businesses.” China must have its own intellectual property and core technologies to produce products with core competitiveness that won’t be beaten in intensifying competition, he said.
- Tax exemptions for tech: The finance ministry said on Wednesday that companies in integrated circuit design and software industries will be exempt from paying income taxes in the first two years if they became profitable before the end of 2018, in line with a State Council directive in early May (Figure 3).
- Fiscal assistance: The government will likely roll out more targeted fiscal support (like tax exemptions) to industries hit by tariffs; to lower corporate operating costs including cutting electricity costs in the manufacturing sector, reducing railway and port charges, and lowering broadband services rates for SMEs.
- Employment stimulus: To address expected rising unemployment, China upgraded this week an earlier inter-ministerial coordination group on employment and work to a State Council leading group, led by Vice Premier Hu Chunhua. It has also announced plans to finance vocational training with CNY100bn from the unemployment insurance fund to upskill the workforce (30 April State Council meeting).
- Fiscal policy is expected to play a bigger role. In addition to the above-mentioned measures, we expect the government to focus in the remainder of 2019 on implementation and execution of committed tax and fee cuts, and pushing local government to start new infrastructure projects.
- Monetary policy will be data- and risk-dependent. The PBoC would step up with more easing, while balancing the goals of managing CNY and leverage, including by guiding interbank rates lower via OMOs/MLFs/TMLFs, targeted RRR cuts, and likely broad-based RRR cuts and policy rate cuts
The next three charts are an excellent summary first of the impact on China exports plus a brilliant timeline of events to watch out for.
Figure 1- China impact
Figure 2: Timeline to watch
Source: China-US trade talk: China fights back, timeline to watch, 14 May 2019. Barclays Research
Figure 3: China’s policy responses
|Date||Bodies||Policy / measure|
|6-May||PBoC||PBoC announced to lower the reserve requirement ratio to for mid- and small sized banks focusing on local economies, with injecting c. CNY280bn of liquidity, effective 15 May.|
|8-May||State Council Meeting||China will move faster to boost innovation in its national economic and technological development zones for further opening up.|
|8-May||State Council Meeting||China will continue the preferential corporate income tax policies for integrated circuit (IC) and software companies. Meanwhile, authorities should focus on improving the supporting policies to further promote the development of IC and software industries to a higher level.|
|9-May||MoF||MoF announced that the public rental housing will be exempt from property tax, land use tax and VAT on rental income, effective from 1 Jan 2019 to 12 Dec 2019.|
|21-May||MoF||In line with a State Council directive on 8 May, the MoF announced companies in IC design and software industries will be exempt from paying income taxes in the first two years (and income taxes cut by half from the third year).|
|23-May||State Council||China upgraded an earlier inter-ministerial coordination group to a State Council Employment Work leading group (led by vice Premier Hu Chunhua) to address expected rising unemployment|
Sources: Xinhua, Barclays Research