Irrational Exuberance On Pending China Trade Deal
China’s stock market continues to be lifted by stimulus and, more importantly, on hopes that Beijing and Washington kiss and make up.
The Shanghai Composite Index rose 1.36% yesterday to close at 2,653. Hong Kong’s Hang Seng gained a lackluster 0.6% to close at 28,123, and the Deutsche X-Trackers China A-Shares (ASHR) exchange-traded fund absolutely clobbered the emerging market universe yesterday, up over 2% while the MSCI Emerging Markets were negative.
This is an odd assumption, that China and the U.S. will end the trade war. U.S. trade representative (USTR) Robert Lighthizer is in Beijing this week to talk trade. He’s part of the dynamic duo of China hawks in President Trump’s cabinet. The other is Peter Navarro. To think that Lighthizer will let China get away with the status quo is pushing it. At best, China gets an extension on the trade war ceasefire, which Lighthizer says ends on May 2, Beijing time. In that case, the U.S. doesn’t increase tariffs from 10% to 25%. For how long, though, is anybody’s guess.
“The USTR publicly embedded the March 2nd escalation date into the Federal Register, which could complicate any attempt to extend the current truce,” thinks Nick Marro, Asia and China analyst for The Economist Intelligence Unit. “At the very least, such a move politically ties the hands of U.S. negotiators: backing down could raise questions over the credibility of the Trump administration’s trade policy, making a future deal that much harder to enforce.”
Markets are highly susceptible to trade talks and rumors of talks. When it looked certain that Trump and his Chinese counterpart, Xi Jinping, would not be meeting during the president’s visit to Asia this month, investors sold. Now there are rumors that Xi will come to Mar-a-Lago again in March. If you’re really upbeat about all this, one can assume Lighthizer and treasury secretary Steve Mnuchin are going to get some sort of concession on intellectual property rights that Trump can then announce during a presser with Xi in Florida next month.
How China concedes on things like technological transfers in joint venture partnerships at a time when American courts are gunning for its premier telecommunications systems firm, Huawei, is a total mystery. Here we have a top executive and the daughter of Huawei’s founder facing allegations of corporate espionage and breaking Iran trade sanctions rules, and yet somehow Xi is going to give American lawyers the chance to sue Chinese companies in mainland China under new intellectual property laws.
According to a Commission on the Theft of American IP, some $600 billion is estimated to have been lost in intellectual property theft over time, though not all of it because of the Chinese. Still, they are the focus. In November, the U.S. Department of Justice indicted Fujian Jinhua Integrated Circuits and its three employees from U.S. firm Micron Technology for stealing Micron’s trade secrets for the benefit of Jinhua, a company majority owned by the state. According to semiconductor industry analysts at investment research firm Smartkarma, “This latest decision by the DOJ marks a major setback for China’s ambitious plans to develop an indigenous semiconductor industry.”
Jinhua is behind a $5.5 billion investment by the Chinese government to build DRAM chips in a bid to bolster the country’s self-reliance in microchips instead of relying on Silicon Valley. The problem is, companies like Jinhua are stealing the know-how. If they are not stealing it, they are getting it for free as part of a deal with foreign firms that says if you want to do business in Asia’s biggest market, you have to fork over some technology.
This is the climate in which Lighthizer is operating. Either Jinhua and Huawei are forgiven, or Xi opens his countries companies to legal challenges at home by U.S. firms who feel aggrieved by their former JV partners who took their tech know-how and started competing companies. This might be the outcome of stronger intellectual property laws in China.
As a result of this crackdown on China stealing trade secrets and growing into the tech powerhouse it has become in Asia, there are now moves to ban Chinese telecom equipment from U.S. networks. “Movement forward on these issues could torpedo the trade talks regardless of what happens before March,” says Marro.
Lighthizer will be discussing more than IP.
Industrial subsidies and enhanced capital controls, among other state-induced measures, demonstrate the concerted manner in which China allocates resources to create wealth and employment at the expense of other economies. Smartkarma research analyst Stewart Peterson says, “International trade in subsidized goods produces inequitable outcomes in the destination country that then erode the moral foundation of capitalism. The survival of market-orientated economics depends upon restoring the sense that the outcomes it produces are fair and trade made with a mercantilist China makes this impossible.”
The U.S. goal is twofold: weaken China’s role in the U.S. supply chain and weaken the Communist Party of China. If there is to be a truly globalized economy, then economic power No. 1 cannot play by one set of rules (democratic system, free-market capitalism) while economic power No. 2 plays by another set of rules (one-party authoritarian system, hybrid capitalism.)
Something’s got to give.
Meanwhile, China’s economy is slowing. The scope for a credit-infused stimulus is limited because Xi thinks they are unsustainable, and he is correct. He needs the trade war to end and cannot afford Lighthizer doubling down on tariffs next month. What will he give in return?
Wall Street does not want more China tariffs either. All the bullish sentiment is due to the belief that this is as bad as it gets. But if Washington considers China a rival and wants to fundamentally force a change to its economy, either they keep on trucking or they throw in the towel in hopes not to tick off the equity markets. If investors are right, team Trump bends as much as Xi. It can happen. If it does, look for Chinese tech companies to be in the crosshairs of the Department of Justice as Washington uses nontariff barriers to target China instead.
If the market is expecting an extension to the 90-day truce and no tariff hikes, then this might be as good as it gets. Tariffs are highly unlikely to wind down—and are more likely to be revved up if China does not produce the kind of outcomes Washington is hoping for.