(What’s Left of) Our Economy: Two Needed Changes in U.S. China Policy

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auditing, Biden, Biden administration, China, currency, dollar, Donald Trump, fraud, investors, national security, SEC, Securities and Exchange Commission, stock market, stocks, tariffs, Trade, Wall Street, yuan, {What's Left of) Our Economy

Although I’ve been pleasantly surprised by how much of former President Donald Trump’s China policies have been retained by President Biden (like the tariffs and tech-related sanctions and tighter export controls), two recent developments reveal how much room for improvement remains – on permitting Chinese entities to list on U.S. stock exchanges, and on those Trump tariffs.

Regarding the stock market issue, Washington incomprehensively keeps giving these entities (they shouldn’t be called “companies” or “businesses” becauuse they have nothing in common with organizations meriting those labels in largely free market economies) the kind of special treatment afforded to members of its stock exchanges from no other countries – including America itself.

Specifically, these Chinese entities continue to be able to raise vital capital in U.S. markets even though they haven’t yet been required to comply with the standards for opening their books fully that are mandatory for every single one of their domestic and foreign counterparts. Therefore, investors can’t make informed decisions, and regulators can’t discover much fraudulent activity.

It’s true that U.S. authorities have just struck a deal with Beijing that potentially gives them the access to Chinese records that they need. But that’s the problem. It’s still “potential.” And the U.S. Securities and Exchange Commission (SEC) may still be bending over backwards to coddle China. Why else would it have agreed with its Chinese counterparts to keep the text of the deal secret? What devils lie in the always crucial details? Full disclosure here is especially important because of Beijing’s long record of violating signed agreements (see, e.g., here) and because the Chinese government’s statement describing its interpretation of its obligation differs significantly from Washington’s – which is virtually guaranteed to produce protracted further bickering.

This typical bobbing and weaving, in fact, raises the question of why the United States has engaged recently – or ever – in any negotiatons in the first place. After all, Washington has been seeking adequate access to the entities since 2007. China has resisted American demands by citing the important national security and other state secrets that unfettered audits might reveal. But as the SEC itself has pointed out (see the preceding link), more than fifty other countries have required their companies to turn over all records as a condition for listing. China clearly has the right to withhold any information it wishes. The U.S. response from the beginning should have been that if a Chinese entity’s operations are so critical to China’s national security, it doesn’t belong in the U.S. financial system, and able to win U.S. and other investment attracted by the Good Housekeeping seal provided by being listed,to begin with.

Washington’s position all along also should have been that there’s literally nothing to talk about. The United States should have declared listing to be a take-it-or-leave-it proposition for China, and that it will serve as judge, jury, and court of appeals (as it is in all cases). As of this past spring, America’s long failure to do so has permitted these entities to amass a market value of $1.3 trillion. And because all of them are always subject to all of Beijing’s whims, that means these valuable resources have been put at the disposal of the Chinese regime.

What to do now?  Ditch the diplomacy stuff and tell Beijing that unless each of its listed entities turn over to U.S. auditors every scrap of information demanded by date certain (meaning real soon), they all get kicked off Wall Street immediately.

When it comes to trade issues, the Biden administration’s mistake is much simpler – and easier to correct. The President deserves considerable praise for the September announcement that the Trump tariffs will be kept in place for the foreseeable future. But China’s predatory trade policies have not remained in place, and in at least one vital respect, have gotten worse – on the value of its currency, the yuan.

For many years, especially in the first decade and a half of this century, Beijing kept the value of the yuan versus the U.S. dollar artificially low. As known by RealityChek regulars, this practice gave goods made in China (including by offshoring-happy U.S.- and other foreign-owned multinational companies) big price advantages the world over for reasons having nothing to do with market forces. The result were equally artificial boosts to Chinese exports and artificial reductions of Chinese imports.

This year, China has doubled down (not literally!) on this tactic, depressing the yuan’s value versus the greenback by fully nine percent. So the American response should be obvious: The tariffs on each of the roughly $370 billion worth of Chinese goods intended each year for the U.S. market should be raised by nine percent also. And each future Beijing move to devalues the yuan another one percent or more should be matched by another equivalent U.S. tariff hike.

This American retaliation isn’t likely to fuel inflation at home, because of falling U.S. demand due to a slowing economy and a shift in consumer spending to services. So importing U.S. companies won’t have the pricing power to pass on their higher costs. But it will put further pressure on a Chinese economy whose other growth engines (like the real estate sector and the domestic consumer market) are faltering mainly because of the deflation of a ginormous Chinese housing bubble and dictator Xi Jinping’s politically inspired crackdown on his own tech companies and his over-the-top Zero Covid policies.

P.S. If China starts strengthening the yuan again, I wouldn’t lower the tariffs in response. For the aim of U.S. policy toward the People’s Republic now can’t afford to be an indulgence like fairness, but weakening this increasingly hostile and dangerous government, and maximum U.S. economic disengagement (often called “decoupling”). But I’d be amenable to some easing of economic pressure and decoupling if I saw major evidence of big, concrete improvements in Beijing’s economic and military policies – say over a five- or ten-year period for starters.

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Those Stubborn Facts: How to Keep Inflating a China Bubble

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bubbles, China, Evergrande, finance, investment, investors, property, real estate, Those Stubborn Facts, Wall Street

Share of global finance industry recommendations on China

investment that were “buys” at the start of this year, before its giant

real estate firms started going broke: 86 percent

 

Share of global finance industry recommendations on China

investment that are “buys” today, when its giant real estate firms

have started going broke: 87 percent

 

(Source: “Down Is Still Up for Foreign Investors Piling Into China,” by Nikos Chrysoloras and Abhishek Vishnoi, Bloomberg.com, October 16, 2021, China Stock Market: Down Is Still Up for Foreign Investors – Bloomberg)

 

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.

(What’s Left of) Our Economy: Trade War(s) Update

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Argentina, Bloomberg.com, Brazil, business investment, China, CNBC, consumption, currency manipulation, debt, Democrats, digital services tax, election 2020, EU, European Union, export controls, Financial Crisis, France, Huawei, internet, investors, manufacturing, production, steel, steel tariffs, tariffs, Trade, Trade Deficits, trade enforcement, trade war, Trump, Wall Street, Wilbur Ross, Xi JInPing, {What's Left of) Our Economy

The most important takeaway from this post about the current status of U.S. trade policy, especially toward China, is that it may have already been overtaken by events since I began putting these thoughts together yesterday.

What follows is a lightly edited version of talking points I put together for staffers at CNBC in preparation for their interview with me yesterday. I thought this exercise would be useful because these appearances are always so brief (even though this one, unusually, featured me solo), and because sometimes they take unexpected detours from the main subject. .

Before presenting them, however, let’s keep in mind this new Bloomberg piece, which came on the heels of remarks yesterday by President Trump signaling that a trade deal with China may need to await next year’s U.S. Presidential election, and plunged the world’s investors into deep gloom. This morning, however, the news agency reported that considerable progress has been made despite “harsh” rhetoric lately from both countries. It seems pretty thinly sourced to me, and the supposed course of the trade talks seems to change almost daily, but stock indices are up considerably all the same.

Moreover, even leaving that proviso aside, what I wrote to the CNBC folks yesterday seems likely to hold up pretty well. And here it is:

1. The President’s latest comments on the China trade deal – which he says might take till after the presidential election to complete – seriously undermines the claim that he considers a deal crucial to his reelection chances because it’s likely to appease Wall Street and thereby prop up the economy. Of course, given Mr. Trump’s mercurial nature, and negotiating style, this latest statement could also simply amount to him playing “bad cop” for the moment.

2. His relative pessimism about a quick “Phase One” deal also seems to reinforce a suggestion implicitly made yesterday by Commerce Secretary Wilbur Ross when he listed verification and enforcement concerns as among the obstacles to signing the so-called Phase One deal. I have always argued that such concerns are likely to prevent the conclusion of any kind of trade deal acceptable to US interests. That’s both because of China’s poor record of keeping its commitments, and because the Chinese government is too secretive and too big to monitor effectively even the most promising Chinese pledges to change policies on intellectual property theft, illegal subsidies, discriminatory government procurement, and other so-called structural issues.

3. Recent reports of the United States considering tightening (or expanding) restrictions on tech exports to Chinese entities like Huawei also support my longstanding point that the US and Chinese economies will continue to decouple whatever the fate of the current or other trade talks.

4. In my opinion, the President is absolutely right to play hard-to-get on China trade, because Chinese dictator Xi Jinping is under so much pressure due to his own weakening economy, and because of the still-explosive Hong Kong situation.

5. I’ll be especially interested to learn of the Democratic presidential candidates’ reactions to Mr. Trump’s latest China statement, as well as the announcement of the reimposed steel tariffs on Argentina and Brazil, and the threatened tariffs on French “digital services” [internet] taxes. With the exception of Massachusetts Senator Elizabeth Warren and Vermont Senator Bernie Sanders, the candidates’ China policies seem to boil down to “Yes, we need to get tough with China, but tariffs are the worst possible response.” None of them has adequately described an alternative approach. The reactions of Democratic Congress leaders Nancy Pelosi in the House and Charles Schumer will be worth noting, too. The latter has been strongly supportive of the Trump approach in general.

6. The new steel tariffs, as widely noted, are especially interesting because they were justified for currency devaluation reasons, with no mention made of the alleged national security threats originally cited as the rationale. Nonetheless, I don’t believe that they represent a significant change in the Trump approach to metals trade, because the administration has always emphasized the need for the duties to be global in scope – to prevent China from transshipping its overcapacity to the US through third countries, and to prevent third countries to relieve the pressures felt by their steel sectors from Chinese product by ramping up their own exports to the US. Obviously, all else equal, countries with weakening currencies (for whatever reason) will realize big advantages in steel trade, as the prices of their output will fall way below those of competitors’ steel industries.

7. Regarding the tariffs threatened in retaliation for France’s digital services tax, they’re consistent with Trump’s longstanding contention that the US-European Union (EU) trade relationship has been lopsidedly in favor of the Europeans for too long, and that tariff pressure is needed to restore some sustainable balance. In this vein, I don’t take seriously the French claim that the tax isn’t targeting U.S. companies specifically. After all, those firms are the dominant players in the field. Second, senior EU officials have started talking openly about strengthening Europe’s “technological sovereignty” – making sure that the continent eliminates its dependence on non-European entities in the sector (including China’s as well as America’s). The digital tax would certainly further the aim of building up European champions – and if need be, at the expense of US-owned companies.

By the way, this position of mine in no way reflects a view that more taxation and more regulation of these companies isn’t warranted. But it’s my belief that these issues should be handled by the American political system.

Also of note: Trump’s suggestion this morning that the French tax isn’t a big deal, and that negotiations look like a promising way to resolve the disagreement.

Finally, here are two more points I wound up making. First, I expressed agreement that the President’s tariff-centric trade policies have created significant uncertainties in the economy’s trade-heavy manufacturing sector in particular – stalling some of the planned business investment that’s essential for healthy growth. But I also noted that much of this uncertainty surely stems from the on-again-off-again nature of the tariffs’ actual and threatened imposition.

As a result, I argued, uncertainty could be significantly reduced if Mr. Trump made much clearer that, whatever the trade talks’ fate, the days of Washington trying to maximize unfettered bilateral trade and investment are over, and a new era marked by much more caution and many more restrictions (including tighter export controls and investment restrictions, as well as tariffs), is at hand.

Second, at the very end, I contended that President Trump deserves great credit for focusing public attention on the country’s massive trade deficits in general. For notwithstanding the standard economists’ view that they don’t matter, reducing them is essential if Americans want their economy’s growth to become healthy, and more sustainable. For as the last financial crisis should have taught the nation, when consumption exceeds production by too great a margin, debts and consequent economic bubbles get inflated – and tend to burst disastrously.

(What’s Left of) Our Economy: Evidence that Business Views on the Trump Tariffs Aren’t What You Think

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Alliance for American Manufacturing, Axios, Canada, China, Europe, investors, Mexico, polls, Rick Newman, tariffs, Trade, Trump, UBS, Yahoo Finance, {What's Left of) Our Economy

You don’t have to have much faith in public opinion results to recognize the following findings as absolute stunners when it comes to U.S. trade policy and President Trump’s efforts at fundamental overhaul: Although numerous surveys recently purport to show that Mr. Trump’s tariff-heavy approach is unpopular overall (see here and here for recent examples), two other polls have just found that the nation’s business community generally approves.

The first comes from UBS, the Swiss-owned investment bank that of course does a great deal of business in the United States. As Axios reported in early August, UBS found that strong majorities of the 300 business owners from twenty industries they questioned (each one was in charge of a company with at least $250,000 in annual revenue) favored tariffs on all of the countries targeted by the Trump administration.

The numbers broke down as follows: China, 71 percent; Mexico; 66 percent; Europe, 64 percent; and Canada, 60 percent.

UBS also asked 501 high net worth investors their tariff views, and most favored tariffs on China – but this share of the sample was smaller (59 percent). And even though trade curbs on Mexico, Canada, and Europe all generated minority support, the levels were impressive nonetheless (45 percent, 33 percent, and 43 percent, respectively).

On Wednesday, Rick Newman of Yahoo Finance reported that that company’s polling on the Trump tariffs produced similar results. The Yahoo Finance findings came from a group of 1,098 “business operators.” Asked to “describe the effect of President Trump’s trade policy” on their company, 49 percent of respondents expressed the “positive” view and 36 percent expected negative consequences.

And here’s the lowdown on the makeup of the Yahoo Finance sample:

“Nearly three-quarters…described themselves as business owners, with 17% saying they’re executives and 4% identifying themselves as board members.

“About 38% of respondents described their companies as small businesses earning less than $1 million in annual revenue. Thirteen percent of their companies earn more than $100 million. Respondents covered every major industry sector, with manufacturing accounting for 19% of responses, followed by retail or wholesale trade (17%), finance (12%), and technology (11%).”

Also worthy of attention is a poll released yesterday by the Alliance for American Manufacturing (AAM), a steel industry-centered group that favors the Trump tariffs. Its survey of 1,200 likely voters found Mr . Trump’s China tariffs winning public support by a 63 percent to 29 percent margin. No data was provided for U.S. policies toward other major economies, but backing for a stricter global approach was strongly indicated by the following description of respondents’ views:

“Three-quarters (75%) agree that ‘free trade is a goal, but in the real world we cannot get there unless we are also willing to use tough measures at the same time,’ including 50% who feel that way strongly. In comparison, only a third (32%) strongly agrees that ‘Free trade agreements have always benefited the U.S. and we should sign more of them.’”

This AAM poll so far does seem to be an outlier, although its questions also look more detailed and pointed than those in surveys reporting more favorable public views of trade and more public opposition to the Trump tariffs. But none of the major polls predicted a Trump electoral college victory in the 2016 presidential elections. It’s entirely possible that their readings on current trade issues are just as off base.

(What’s Left of) Our Economy: Why Today’s Fed Rates Announcement Really Matters

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asset prices, bubbles, federal funds rate, Federal Reserve, Financial Crisis, financial markets, Great Recession, interest rates, investors, Janet Yellen, moral hazard, Obama, OECD, recovery, {What's Left of) Our Economy

As the world economy anxiously awaits the Federal Reserve’s announcement this afternoon about how much longer it will keep the interest rates it controls near zero, the release yesterday of a new official report on global growth prospects is especially well timed. The latest global economic assessment from the Organization for Economic Cooperation and Development (OECD) valuably reminds the world’s leaders and publics alike that the main economic challenge of our time is not quickening the slow pace of recovery from the financial crisis and Great Recession. Instead, it’s generating the kind of robust growth that won’t almost inevitably trigger another crisis.

The OECD, an organization of the world’s high income countries (and some middle-income countries, like Mexico), raised its projections for overall global growth, and for growth in most major countries and regions, from those in its previous forecast in November. (Most of the main old and new numbers were conveniently presented in this Financial Times piece.) But the OECD also warned that too much of this improvement stems from the same forces that during the last decade inflated asset bubbles around the world that eventually burst disastrously.

In addition to lower oil prices, OECD chief economist Catherine L. Mann contended, monetary easing has “brought the world economy to a turning point, with the potential for the acceleration of growth that has been needed in many countries.” But she also specified that “excessive reliance on monetary policy alone [like the massive easing implemented by the Federal Reserve since the crisis broke out] is building-up financial risks, while not yet reviving business investment.”

As the United States and the rest of the world should have learned since the dark days of 2007-2009, no challenge is easier for governments to meet than creating the illusion of growth temporarily. They can simply promote borrowing and spending that have nothing to do with genuine wealth creation and the rising incomes it produces.

Actually, I’ve been surprised at how long easy money from the Fed and other leading central banks has kept the world economy afloat in the last few years. But this extraordinary official subsidization of economic activity is showing big signs of the same dangerous consequences produced by wildly excessive credit creation before 2007-8. It’s spurred a flood of capital into ever more dubious schemes from investors desperate for decent returns but also fully confident that governments will protect them from any risk. After all, if resources can be created at will by monetary authorities, and losses will be covered, why not throw caution to the wind? Why spend lots of time trying to figure out how to use them carefully or productively?  Why not take full advantage of what economists call “moral hazard”?

Ironically, and encouragingly, these worries about oceans of capital being invested without significant market disciplines seem to be shared by what has so far been the world’s biggest credit pusher – the Federal Reserve, or at least many of its leaders. At least as of this morning, that’s why it’s been widely reported that Chair Janet Yellen and her colleagues will start preparing markets and the rest of the world for the likelihood that they’ll raise the federal funds rate sooner rather than later – if only by a little. That also appears to be mainly why, for all the boosterism surrounding the U.S. economy throughout the current recovery – including President Obama’s claim that the nation has “turned the page” – American investors are reacting to even a modest rate hike so bearishly. They recognize that artificial legs have been the only legs that asset prices and the underlying real U.S. economy have been showing.