(What’s Left of) Our Economy: U.S.-China Decoupling Help…From China!

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China, decoupling, Didi, Didi Chuxing, finance, investing, IPOs, national security, privacy, stock markets, tech, Wall Street, Xi JInPing, {What's Left of) Our Economy

Here’s an absolutely stunning and potentially crucial development that I sure didn’t anticipate: The Chinese government is emerging as one of the most powerful forces working to decouple the American and Chinese economies.

In fact, Beijing’s recent crackdown on Chinese entities (remember: since China has no free market economic or financial system, these organizations shouldn’t be called “companies” or “businesses”) could rival the tariffs and the technology curbs imposed by the Trump administration and continued by President Biden as a means of (1) reducing America’s dangerous economic reliance on this increasingly hostile rival, and (2) cutting the long-time outflow of valuable U.S. capital and knowhow that inevitable enriches and strengthen the People’s Republic.

This turn of events is so unexpected, because, as I’ve written, finance looms as the one policy front on which decoupling had made the least progress.  Worse, despite the obvious and more subtle threats posed by this trend to individual investors (described insightfully here by investment analyst and friend Steven A. Schoenfeld), not to mention to American security, prosperity, and privacy, the flow of U.S. capital to the People’s Republic kept swelling. So far this year alone, a record $12.5 billion has been raised for Chinese entities on U.S. stock markets in 34 listings – way up from $1.9 billion worth of new listings in 14 deals during the same period last year. And many more seemed on the way.

But don’t think that these numbers come anywhere close to revealing China’s presence in U.S. finance. The kinds of initial public offerings (IPOs) mentioned just above have been appealing to Chinese entities and to the regime because with the U.S. exchanges the world’s biggest by far, passing muster with them is like a Good Housekeeping Seal of Approval. Therefore, it’s inevitably encouraged investors the nation and world over to pile in. As a result, the total market capitalization of these entities stood at no less than $2.1 trillion as of two months ago.

In recent days, however, China has made clear that some national security concerns of its own, along with dictator Xi Jinping’s determination to bring these gigantic, highly advanced organizations closer to heel, were now outweighing the prospect of continuing to attract more oceans of U.S. and other global investment. Just two days after ride-sharing giant Didi Chuxing raised a record $4.4 billion in a June 30 Wall Street debut, Beijing’s internet regulators ordered it to stop signing up users. This past Monday, China ordered that its app be removed from Chinese app stores (as recounted here).  The announced justifications: the need both to protect national security, and users’ personal data. 

But since China’s leaders are not exactly known as champions of personal privacy, the former was surely the real reason, along with the desire to reassert control. Last weekend, in messages presumably endorsed and even placed by Chinese authorities on the Twitter-like platform Weibo, Didi was actually accused of transferring the data it collected overseas.

Since then, moreover, the crackdown has gone beyond Didi. On Monday, China also announced a cyber-security review of two entities also listed in U.S. markets, and The Wall Street Journal reported that Chinese regulators had suggested that Didi postpone its IPO. The following day, Beijing “issued a sweeping warning to its biggest companies, vowing to tighten oversight of data security and overseas listings just days after Didi Global Inc.’s contentious decision to go public in the U.S.”

This news, along with the beatings taken by the share prices of these U.S. listed companies and major counterparts in trading worldwide, have prompted widespread speculation that the Chinese IPO wave in American finance is over, a least for the time being. And almost right on cue, reportedly today a Chinese entity decided to drop its own U.S. IPO plans because of Beijing’s new stance. 

Wall Street of course isn’t happy – huge underwriting and trading fees stand to be lost. But China’s evident change of priorities represents a golden opportunity for U.S. leaders to jump in and lend a helping hand. They should make the regulatory moves needed to keep Chinese entities out of U.S. markets for good going forward, and speed up efforts to kick out those remaining. And as is not the case with other decoupling policies, American officials seemingly can be certain that China’s powerful flunkies in the Washington, D.C. swamp won’t be trying to gum up the works.

Our So-Called Foreign Policy: Long Overdue Curbs on U.S. Financial Investment in China Seem at Hand

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CCP Virus, China, coronavirus, COVID 19, cybersecurity, government workers, human rights, investing, investors, MSCI, national security, Our So-Called Foreign Policy, pensions, privacy, rogue regimes, sanctions, Steven A. Schoenfeld, surveillance, Thrift Savings Plan, Trump, Wuhan virus

A major debate has just broken into the open over some crucial questions surrounding the future of U.S.-China relations. Chances are you haven’t read about it much, but it essentially involves whether Americans will keep – largely unwittingly – sending immense amounts of money to a foreign regime that was long posing major and growing threats to America’s security and prosperity even before the current CCP Virus crisis. The details, moreover, represent a case in point as to how stunningly incoherent America’s China policy has been for far too long.

The controversy attained critical mass this week when the Trump administration on Monday “directed” the board overseeing the main pension plan for U.S. government employees and retirees (including the military) to junk a plan that would have channeled these retirement savings into entities from the People’s Republic. The President can’t legally force the managers of the Thrift Savings Plan (TSP) to avoid China-related investments. But he does have the authority – in conjunction Congressional leaders – to appoint members to the board, and has just announced nominations to fill three of the five seats. 

This afternoon, the board announced that its recent China decision would be deferred. But because it’s still breathing, all Americans need to ask why on earth the U.S. government has ever allowed any investment in shares issued by entities from China (as known by RealityChek regulars, I refuse to call them “companies” or “businesses,” because unlike their supposed counterparts in mostly free market economies, they’re all ultimately agents of and most are massively subsidized by the Chinese government in one way or another). And why doesn’t the board just kill off the idea for good?    

After all, at the very least, Chinese entities often engage in the most fraudulent accounting practices imaginable, thereby preventing outsiders from knowing their real financial strengths and weaknesses. As just pointed out by Trump administration officials, many also play crucial roles in China’s human rights violations and engage in other practices (e.g., hacking U.S. targets, sending defense-related products and technologies to rogue regimes) that could subject them to national or global sanctions. Worst of all, the thick and secretive web of ties between many of these entities and the Chinese military mean that in a future conflict, U.S. servicemen and women could well get killed by weapons made by Chinese actors partly using their own savings.

Further, government workers’ savings aren’t their only potential or even actual source of U.S. financing. Any American individual or investment company or private sector pension plan is currently allowed to direct money not only toward any Chinese entity listed on American stock exchanges (even though regulators keep complaining about these entities’ lack of transparency – while generally continuing to permit their shares to trade). Such investment in Chinese entities listed on Chinese exchanges is perfectly fine, too. In addition, as documented on RealityChek, U.S.-owned corporations have long been remarkably free to buy stakes in Chinese entities whose products and activities clearly benefit the Chinese military.

Still, the idea of the federal government itself significantly bolstering the resources of China’s regimes belongs in wholly different categories of “stupid” and “reckless.” And don’t doubt that major bucks are involved. The total assets under management in the TSP amount to some $557 billion. And about $40 billion of these are currently allotted to international investments. (See the CNBC.com article linked above for these numbers.)

Could there be any legitimate arguments for permitting these monies – most of which are provided by U.S. taxpayers – to finance an increasingly dangerous Chinese rival? Defenders of the TSP China decision (prominent among whom are officials of public employee unions, who seem just fine with underwriting a Chinese government whose predatory trade practices have destroyed the jobs and ruined the lives and jobs of many of their private sector counterparts) maintain that the prime responsibility of the managers is maximizing shareholder value. And since the TSP had decided that the optimal mix of international holdings are essential for achieving this aim, it quite naturally and legitimately decided to move its overseas investments into the MSCI All Country World ex-US Investable Market index.

This tracking tool and the fund it spawned are widely considered the gold standard for good investment choices lying outside the United States, and in early 2019 decided to speed up a previous decision to triple the weighting it allots to China companies. The share is only about three percent, but who’s to say it stops there?

The TSP board unmistakably should be mindful of its fiduciary responsibilities to current and former federal workers. But as noted by the Trump administration, how can it adequately promote them when it’s transferring their savings into Chinese entities that are simply too secretive to trust and that may be crippled by U.S. sanctions?

More important, as managers of a government workers’ pension fund, TSP board members can’t expect to be treated like private sector fund managers. They clearly have responsibilities other than maximizing shareholder value, and undermining U.S. policies toward China (or on any other front) can’t possibly be part of their mandate.

Bringing the TSP in line with the broader emerging U.S. government approach to China wouldn’t solve the entire problem of huge flows of American resources perversely adding to Beijing’s coffers. This article by investment analyst Steven A. Schoenfeld (full disclosure: a close personal friend) details the alarming degree to which MSCI along with other major indexers have increased the China weightings in their emerging markets indices in particular to alarming levels – levels that aren’t easy to reconcile with the imperative of investment diversity, and that haven’t exactly been broadcast to the large numbers of individual investors who rely on them.

Even immediate, permanent new restrictions on TSP would do nothing to address this issue. Nor would they affect continuing private sector investment in Chinese entities that supply that country’s armed forces, and that strengthen its privacy-threatening hacking and surveillance capabilities.

But TSP curbs would be a start. And any TSP managers that don’t like them can quit and go to work on Wall Street.

Making News: Podcast of New BBC Interview on China and Global Markets

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BBC, China, China stock markets, currency, currency wars, devaluation, emerging markets, export-led growth, Federal Reserve, finance, interest rates, investing, Making News, monetary policy, recovery, Trade, Wall Street, yuan, ZIRP

I’m pleased to announce that I was interviewed on the BBC this morning on China’s economic and financial turmoil, and how it’s been shaking the world’s economy and financial markets.  Click on this link for the podcast.  My segment is titled “Global Markets React to China’s ‘Black Friday'” and yours truly comes in at about the 7 minute-50-seconds mark.

Moreover, even as we speak, I’m working on a more detailed analysis that I hope to post shortly.  Stay tuned!

(What’s Left of) Our Economy: Japan Goes All In

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asset prices, Bank of Japan, bubbles, currency, currency manipulation, dollar, Fed, Financial Crisis, free markets, Global Imbalances, investing, Japan, QE, stimulus, Trade, Trans-Pacific Partnership, yen, {What's Left of) Our Economy

I was already having a hard enough time trying to figure out whether to focus this morning on three big data releases or on some of the other economic and non-economic developments crowding the headlines – and then the Japanese government rocked the economic world with two mega-announcements.

So the Labor Department’s Employment Cost Index, the Commerce Department’s survey of personal incomes and saving, and the Chicago purchasing managers‘ new monthly sounding all will have to take a back seat to the Japanese central bank’s unveiling of a massive new stimulus program, and the Japanese government pension fund’s announcement that it’s going to start investing considerably more in stocks both in Japan and around the world.

There’s no need to review the most obvious implications of this news. Just Google “Bank of Japan” and “GPIF” (Government Pension Investment Fund). You’ll quickly see that the former’s decision to buy many more Japanese government bonds, along with stocks and other financial assets, is expected to boost the prices of the such assets all around the world, further weaken Japan’s yen, and fend off another bout of deflation — with all the damage that would do to the Japanese and global economies. Financial assets will also get a major lift – all else equal of course! – from the Japanese government employee pension fund (the world’s biggest public sector investor) shifting its strategy to buying more stocks in Japan and abroad.

To me, the less obvious implications matter more, especially these two:

First, one of the biggest long run dangers of the unprecedented central bank stimulus programs adopted to contain the financial crisis is that investment capital around the world will be spent badly. The idea is that if investors know that the Federal Reserve and the European Central Bank or the Bank of Japan will ride to their rescue with yet more credit if they make mistakes in allocating funds, the discipline that’s supposed to be one of the main virtues of free markets and capitalism will be badly eroded and possibly destroyed.

The crisis itself clearly was fueled in the first place by the glut of credit provided by the Fed in particular during the bubble decade. Super-easy money encouraged both Wall Street and homeowners to bid up the price of fundamentally unproductive assets like houses wildly beyond sensible levels. Government housing subsidies and implicit guarantees didn’t hurt, either.

The Fed doesn’t buy stocks but its Japanese counterpart has invested in exchange-traded funds and real estate investment trusts. Now the Bank of Japan will triple those purchases, along with boosting its bond buys. Is it remotely possible that this step will increase the efficiency of capital allocation in Japan, the United States, or anywhere?

In addition, the $1 trillion-plus Japan government pension fund, the world’s largest public investor, will more than double its holdings of Japanese and foreign stocks to 25 percent each. Of course, public pension funds have long been major players in financial markets. But U.S. funds hire private sector investment professionals to manage their portfolios. That hardly makes them perfect, but at least they have a history of responding in standard ways to market (and more recently, government and central bank) signals.

The GPIF’s portfolio, by contrast, is run by government bureaucrats. Moreover, they’re bureaucrats from the Japanese government, whose devotion to free markets has been historically difficult to spot. I’m someone who actually thinks that Tokyo has a good record of intervening in the economy, especially in manufacturing. But that doesn’t mean I have much confidence in it as a stock- or sector-picker – which of course is a different animal altogether from identifying approaches to nurture the long-term development of industries. Moreover, why would anyone hewing to the conventional wisdom about Japan’s allegedly disastrous penchant for “picking losers” believe that its leaders will now suddenly start making decisions that improve the efficiency of their own economy, let alone economies anywhere else?

The second less-than-obvious set of implications of Japan’s new policies concerns trade flows and trade policy. As widely recognized, the extra BOJ bond-buying has already brought the yen to roughly seven-year lows versus the U.S. dollar. The question Washington needs to ask is why it’s still pursuing a Trans-Pacific Partnership trade deal when the biggest economy involved in the talks so far outside the United States, which already has a strong record of protectionism, has just moved to cheapen the price of its exports and raise the price of its imports – and all for reasons having nothing to do with market forces?

Further, this latest instance of Japanese currency manipulation will likely affect trade flows more than Fed easing ever could – even if ZIRP and QE haven’t been accompanied by a stronger, not weaker dollar. For as defenders of this Japanese exchange-protectionism keep ignoring, the BOJ isn’t simply mimicking the Fed because monetary easing policies in a mercantile, production and export-led economy like Japan’s will always have fundamentally different – and inevitably more protectionist – effects than easing policies in a consumption- and import-focused economy like America’s.

Finally, even though Washington reportedly is more determined than ever to ignore foreign currency devaluations in the mistaken belief that its leading, and slow-growing, trade partners deserve such help, the much weaker yen is likeliest to spur similar moves – or the introduction of other beggar-thy-neighbor measures – in other mercantile, export-led economies in Asia, notably Korea and China.

Without a meaningful U.S. response – meaning a sharp turnabout in import- and deficit-friendly American trade policies – the inevitable results will be an even bigger U.S. trade shortfall, a consequently weaker American recovery, and reflation of the global imbalances that played such a prominent role in triggering the financial crisis to begin with. Unless, finally, this time, for reasons no one has yet identified, it really is different?

(What’s Left of) Our Economy: The Biggest Bubble of Them All

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bubbles, central banks, Federal Reserve, Financial Crisis, investing, stocks, {What's Left of) Our Economy

As all savvy investors are supposed to know, the Dow Jones Industrial Average breaking through the 17,000 mark – as it still could today – means bupkis. That is, it’s one of those round-number psychological levels that only suckers take seriously. Not that that will stop the financial news networks from continuing to obsess about this milestone, or the headlines from trumpeting it, if and when the moment comes.

Still, Dow 17,000 (like the somewhat more distant S&P 500) is a useful occasion for again contemplating the yawning disconnect between record asset prices pretty much all over the world and historically humdrum levels of growth and job creation in the real economy that of course have been artificially juiced by central bank stimulus.

I buy the standard explanation – that the very stimulus that has dramatically depressed interest rates in practically all major countries has spurred investors to seek the higher returns offered so far by equities and by tangible assets like real estate (but not necessarily like gold). I also buy the slightly-less-standard explanation that American businesses in particular have gotten so good at doing more with less that they can keep racking up record profits despite laying off many of their best customers (their workers), and driving down the wages of many others.

And I buy the widespread worry that none of this is sustainable, even with brazen enabling by the Federal Reserve, which artificially props up purchasing power throughout the U.S. economy (although I remain stunned at central bankers’ abilities to keep this high-wire act going as long as they have). But my main concerns are slightly different from the usual, because my analysis of the situation adds one element that’s typically neglected.

As I see it, the U.S. multinational companies that dominate stock trading in America have sold investors on a theme they can’t advertise in public but that’s been consistently and broadly suggested in analysts’ conference calls for two decades. They’ve made clear that they view the U.S. consumers that they’ve employed as being ultimately expendable because literally billions of new consumers in developing countries will steadily take their place.

There’s no doubt that a great deal of wealth has been created since the 1980s in countries like India and Mexico and especially China – along with a new generation of avid shoppers at many income levels.

But here’s the problem: As I showed in this article earlier this year, the best data available show that only 30 percent of third world workers earn the equivalent of $4 per day or more. And that figure is based on a way of measuring incomes across borders that greatly exaggerates their ability to buy products made in high-price/high-cost countries like the United States.

So to me, anyway, the U.S. consumer looks irreplaceable, even for the most efficient multinational company. We’re still a ways from the point where American consumers will have to be entirely or even largely replaced. But we keep moving closer to it thanks to the trade policies that Washington has pushed for roughly two decades – which keep needlessly sending overseas so much of America’s most valuable production, and so many of its family-wage jobs.

Think of it this way: Offshoring-friendly and other shortsighted U.S. trade policies keep sending consumption power to populations that for decades will remain far too poor to consume and import anywhere near what their prodigious numbers would suggest. And they keep stripping the world’s leading consumers – Americans – of much of the income-earning opportunities they need to pay for their consumption responsibly.

The unheard of global trade and investment and credit imbalances created by these trade policies have already blown up in the nation’s face – and indeed, the world’s face – in the form of the 2008 financial crisis whose stage they helped set. With the U.S. trade deficit now rebounding steadily from its recession lows, a repeat seems inevitable without a major policy course correction.

My forecast? (And please – do not take this as investment advice!) There’s no reason to expect that the troubles of the real economy will catch up with roaring financial markets. That is, this biggest bubble of them all will keep inflating. Until it bursts.