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China Beige Book

'Trump's tariffs just first shot—the big China action is Section 301'

Leland points out that President Trump's really big trade move against China yet to come, that is, Section 301 penalties. If you aren't up to speed on 301, you will be after you read and watch Leland's comments. As Leland says, with Section 301, 'regardless of how Section 232 steel and aluminum tariffs end up in the next few days - you're seeing the beginning, not the end, of Trump's aggressiveness on trade.' 'And, I don't think people have prepared themselves yet for the fact that 301 is coming.'

1. 'Today's tariffs just Trump's first shot - the real China action is Section 301'

[Note: If you're not up on the difference - and it's a vitally important difference - Section 232 and Section 301, please go to part 2, below.]

Leland Miller, CEO of China Beige Book told me: 'Donald Trump just announced several minutes ago that he was indeed going forward with Section 232 tariffs on steel and aluminum. Here's my take and some context.'

'When the Trump administration was originally developing the strategy for responding to China trade problems, they evaluated two major lines of attacks using tariffs.'

  • 'One line of attack was Section 232 - that's what you're hearing about today.'
  • 'Today's 232 move is just for steel and aluminum tariffs, it's not China specific, and it's something that relies on the ability of the White House to be able to say, "National security dictates that we regulate these imports with particular tariffs."
  • ''The big problem with that as a China move: China is not a major exporter steel or aluminum to the U.S. So, this is not really something that's going to hit China particularly hard directly.'
  • 'Indirectly, this will hit China. China has been sending its steel through third-party countries in Southeast Asia and elsewhere so that it comes into the U.S. not identified as Chinese. Today's action is partly designed to stop this.'

'But, because these are tariffs on global imports, this is going to upset a lot of America's strongest allies.'

  • 'You're already having foreign delegations rush to the White House right now to lobby to get them out, carve them out.'
  • 'Trump hasn't signed anything yet. So, you could see carve outs for allies in the final document.' 

'What the President might do after making such a splash today brings us to the other line of attack: Section 301.'

  • 'Section 301 has always been the White House's underlying platform - its center- for the anti-China assault on the trade side.'
  • Why? 'Unlike Section 232, Section 301 targets unfair trade practices, not products; and it targets a specific country, not the whole world.'
  • 'So, with 301, the President has the power to basically do whatever he wants to China on the tariff side in order to deal with the fact that the Chinese have been stealing intellectual property and a 301 investigation has found them guilty of that.'

'In response, he has the option to either have a very mild action or something that would be much larger than what he announced today with Section 232 tariffs on steel and aluminum, much more severe.'

  • 'If he went for something severe, such as broad sectoral tariffs - tried to take down, say, China consumer electronics - then, you would have justifiable reason to call this a trade war.'

'With today's 232 tariffs on steel and aluminum, there was actually strong opposition across the government, across the administration. Even within the White House where, except for a handful of people, advisors were very, very against this - they think Trump's opening up Pandora's box.'

  • 'So, it's interesting that there's not much opposition to the country-specific Section 301.'
  • '301 is likely to go forward as planned. We just don't know how big yet.'

'How big 301 actions will be depends on how this 232 tariffs saga ends up'.

  • 'As I mentioned, if 232 goes forward in anywhere close to the current way it's being described by the President, it is absolutely against the wishes and inclinations of almost everyone, within most of the industries, even within the Trump White House.'
  • 'Republicans in Congress don't want it, either. So there's a lot of politics to this.'
  • 'The President's backed himself into a little bit of a corner - I think you're most likely going to see 232 going forward, but the chances are that it gets pulled back some.'
  • 'All this is something that's going to have to be sorted through before the President decides whether these 232 tariffs are enough, whether he has to pull 232 back a bit, or whether he wants to go even bigger with 301.'

'The President's impulse seems to be to go bigger. And 3o1 - it's faster, it's louder, it's bigger, than other routes, such as going through WTO processes.'

  • 'Section 301 essentially allows the President to right the wrongs that he believes have not been dealt with by the WTO.'
  • 'Wrongs that in his mind and in the minds of Wilbur Ross and Peter Navarro and Bob Lighthizer that the Chinese have been committing for years, for decades now.'
  • 'Where WTO has not done anything about them, and other Presidents have not done anything about them, he will.
  • 'And, quite frankly, what the President wants here is a big splash - if he uses 301, he can show that his campaign rhetoric about being a strong warrior on trade is credible.'

'For these reasons, I believe that you're seeing right now - regardless of how 232 ends up in the next few days - you're seeing the beginning, not the end, of Trump's aggressiveness on trade.' 

'And, I don't think people have prepared themselves yet for the fact that 301 is coming.'

 

2. Section 232 & Section 301: The Difference

Leland Miller explains the difference between Section 232 (Trade Expansion Act of 1962) and Section 301 (Trade Act of 1974).

'Broadly speaking, these are two very different measures.'

  • 'Section 232, is product specific and focuses on whether imports of that product threaten U.S. national security. The President can take any actions to “adjust the imports of an article and its derivatives” or other non-trade related actions he thinks are necessary to protect national security.'
  • 'Section 301 is country specific and allows the U.S. to impose trade sanctions on foreign countries that either violate trade agreements or engage in other unfair trade practices.'

'The Section 232 tariffs the President has announced today are specifically for steel and aluminum.'

  • 'Steel and aluminum are each the subject of an active 232 investigation and their imports have been deemed threats to national security.'
  • 'Because of these findings, the President has declared their import  threats to national security, and that's why he's taking action on them.'
  • 'When he signs the tariff orders, the effect is global. That means, the President is putting steel and aluminum tariffs on imports from everywhere around the world, but he can carve out certain countries to be exempt.'

'Section 301 is very different -  it's country specific, not product specific.'

  • 'Section 301 has to do with unfair trade practices - in this case, it is intellectual property theft, and it is a China-specific investigation that nailed China.'

 'The idea behind how to push an aggressive trade front against China has always been centered around 301.'

  • 'That's the way you really get at China, not through 232, which is global, but through 301, which allows China-specific application.'
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A world of debt mortgages our economic future

Reuters
Irresponsible borrowing by the US, China and India imperils global growth

What is not natural is China’s bad track record on debt: according to the Bank of International Settlements, every measure of debt — consumer, government and corporate — has risen as a share of GDP for the past decade. China went from a low-leverage country in 2007 to having a worse debt position than the US in 2017, despite the fact that the US itself has borrowed heavily.

Those who can’t lead, borrow. The American, Chinese and Indian governments boast of the strength of their economies, yet they are also borrowing intensely. Such a situation is not only contradictory, it will also prove harmful to their chances at global leadership in the future. A strong economy means government should spend less and not need to borrow at all. In all three countries, policymakers appear oblivious to the consequences of failure on this score. Will the US or China lead in coming decades? When will India become a global challenger? The answers may be neither and never. Instead the world could see a slow slide into a long stagnation.

Few people consider India a truly global actor but, within the next 20 years, it will have both the world’s largest population and largest labour force. It will be difficult in 2040 for the global economy to be healthy if the Indian economy is not. There is obviously a long way to go before then, and India is not going in the right direction. The government of Narendra Modi, prime minister, is obsessed with the title of “fastest-growing major economy” and insists India will reclaim that spot in 2018 or 2019.

Yet central government borrowing will rise this year as a share of GDP, from an already excessive figure. The core of the higher deficit is a jump in the simple revenue shortfall, which overwhelms one-time accounting tricks used by politicians everywhere to dress up ugly budgets. In addition, Indian states borrow even more intensively than the national government.

A country growing rapidly with a young workforce should not need to do this. More important, a poor country which seeks at least a full generation of such growth should not borrow against that future. India is showing neither the vision nor will to become an economic leader.

Many would claim China already is such a leader. It qualifies in terms of size and no shortage of people tout its performance. They acknowledge that Chinese GDP growth, for instance, has slowed by half in the past 10 years, but point out this is natural as the size of GDP expands.

What is not natural is China’s bad track record on debt: according to the Bank of International Settlements, every measure of debt — consumer, government and corporate — has risen as a share of GDP for the past decade. China went from a low-leverage country in 2007 to having a worse debt position than the US in 2017, despite the fact that the US itself has borrowed heavily.

The bulk of Chinese debt is corporate, not explicitly government. But the bulk of corporate debt has been incurred by state-owned enterprises and underwritten by central and local government, as these firms borrow almost entirely from state-owned banks. It is thus China’s central government which has authorised a decade-long explosion in debt accumulation, even while trying to convince the world it offers a superior model of development.

Those who favour US global leadership can be reassured by China’s poor choices. But America’s own choices are disturbing. The US already faces enormous spending obligations in the form of entitlement programmes. Combined national government spending on healthcare hit $1tn in 2015 and social security spending is projected to hit an additional $1tn this year.

The 2017 federal budget deficit was $650bn and expected to rise over time as the country ages. Now, enter the tax cut. Congress and the administration had reason to cut corporate tax rates, but they did so by $1.5tn and with no offsetting tax increase elsewhere. The recent spending bill adds $300bn to that.

The federal deficit could thus reach $1tn in 2018 and, if not this year, then next. This is not happening during a crisis like the one in 2008. While there are problems with labour force participation and inequality, unemployment is 4.1 per cent and the US economy added $7tn in wealth over the most recent 12 months. Yet national debt is set to soar.

US federal borrowing has no justification. If China is telling the truth about its economy, it has no excuse for its corporate debt. If India wants a bright future, it cannot mortgage it now. No country has ever prospered from heavy government borrowing when times are good. Yet this is what the world’s economic leaders have to offer. They are walking into quicksand and could drag everyone else with them.

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What we import from China

But he can’t keep saying China is ripping us off and he’s going to stop it unless the US targets the biggest imports. The trade deficit with China is bigger than with the next eight countries combined. NAFTA? The trade deficit in cell phones and computers alone with China is bigger than the trade deficits for all goods with Mexico and Canada combined.

The first year of the Trump presidency saw a record US merchandise trade deficit with China, $375 billion. Exports were the most ever. Unfortunately for the president, so were imports, breaking $500 billion. Even in Washington, half-a-trillion is real money, especially if it will be followed by more of the same.

What is the US buying? One of the many annoying things about trade is all the ways there are to slice up the numbers. Using “3-digit SITC,” because it rolls so trippingly off the tongue, here are the top 10 goods imports from China last year:

This is over half of all imports. Banning a product not on this list — not slapping with high tariffs, banning outright — would cut the trade deficit only 3% or less.

Steel, for example, gets a lot of attention. Combined 2017 steel and aluminum products from China were worth barely half as much as radios. Getting rid of them entirely would leave the bilateral trade deficit at $370 billion, still a record. Solar panels, which have already been hit with tariffs, are so unimportant they don’t even have a category.

So steel and solar don’t matter at all to the trade deficit. Nor does it help to talk about how China should buy more US exports. The last five years of exports to China read $122 billion, $126 billion, $116 billion, $116 billion again, and $130 billion last year. This year isn’t suddenly going to see $250 billion. If we’re lucky, it will see $150 billion.

That probably won’t keep up with 2018 imports. The Republican tax plan is bad for national debt but should put more money in people’s pockets. More money means more spending, including on imports. A rise in US exports to China to $150 billion would be 15%. A 15% rise in imports from China would be $75 billion, meaning a $430 billion deficit this year.

It would be perfectly reasonable for the president to say, “If Americans are buying more things made in China because they have more money, there’s no problem.” A lot of people would agree with that, for good reasons.

But he can’t keep saying China is ripping us off and he’s going to stop it unless the US targets the biggest imports. The trade deficit with China is bigger than with the next eight countries combined. NAFTA? The trade deficit in cell phones and computers alone with China is bigger than the trade deficits for all goods with Mexico and Canada combined.

There are of course drawbacks to restricting cell phone, computer, and toy imports — people will have to pay more for those things. Unlike steel, exporting those goods is truly important to China and they can retaliate against US soybeans, for example. Eggs have to get broken before the omelette gets made.

Until then, until the main Chinese exports are addressed, “trade war” talk is much ado about nothing. For better or worse, until the Trump administration targets China-made cell phones, computers, toys, furniture, and clothing, US trade numbers will look pretty much the same.

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Is China's Economic Power a Paper Tiger?

The People’s Republic of China has surely seen faster GDP growth than the United States for most of the past forty years. It's the value of that growth that's questionable.

The Chinese economy is strange in many ways. Not only is it a hybrid between private capital and state control, but very few people directly invest in the mainland — and yet everybody is interested in how the second largest economy in the world is going to develop. That’s because Chinese demand determines the prices of world commodities, and the operations of multinational companies in China impact earnings. When the yuan falls, markets across the world get jittery. China watchers accept the fact that official Chinese data is severely flawed, and often simply fabricated, yet they still use it to analyze the Chinese economy and markets because there are few alternatives. One alternative, however, is the China Beige Book International (CBB), a research service that interviews thousands of companies and hundreds of bankers on the ground in China each quarter. They collect data and perform in-depth interviews with Chinese executives.

This article is appeared on The National Interest

GDP Is Overrated, or Worse

It seems strange to say this with China having reported faster growth in gross domestic product (GDP) for decades. First, it’s worth asking if and when Beijing will admit that its economy struggled. For instance, China reported 7.9 percent GDP growth for the second quarter of 2009 yet continued the world’s largest loan program, and saw much of it turn to debt despite the supposedly fast growth. It’s almost as if the economy did not do nearly as well as the Communist Party claimed.

Still, the People’s Republic has almost surely seen faster GDP growth than the United States for most of the past forty years. The question is its value. For ordinary Chinese, disposable income (as reported by Beijing) is less than halfof GDP per capita. Disposable income is money that can actually be spent while GDP per capita is an accounting device, with little relevance in the real world.

Even less relevant is GDP adjusted by purchasing power parity (PPP). PPP requires computing a price level for all of China and comparing it to all of America, itself slightly absurd. It relies on “the law of one price”—arbitrage across open markets causing prices for the same product to equalize. Chinese market barriers mean arbitrage often fails. Related, PPP is meant to apply to consumer buying power, while consumption is less than 50 percent of Chinese GDP. GDP adjusted by purchasing power is a poor measurement for many countries, including China.

Net Private Wealth

Simple GDP is better than that, but it’s far from the only measurement and may not be the most important. The resources available to countries to pursue national interests are captured in net national wealth, which again takes the form of money that can be spent rather than an accounting result. If conceptualized and measured accurately, annual GDP should capture contributions over time to the stock of wealth. It should be not be surprising that Chinese GDP turns out not to be tightly associated with wealth.

Credit Suisse compiles net private wealth in most national economies going back to 2000. The data are unstable in that there can be later revision, so the most recent results should be considered tentative. Against that, there are two reassuring features: (i) any bias should be considerably smaller than the bias of the Chinese government and (ii) the results do reflect China’s rise through 2012.

From 2000–2012, net private Chinese wealth jumped from $4.66 trillion (less than India’s today) to $21.7 trillion, close to a 14 percent annual growth rate. American net private wealth over the same period rose from $42.3 trillion to $67.5 trillion. While the absolute advantage for the United States expanded, it did so by only $8 trillion because U.S. annual growth was only four percent. China was easily outperforming.

The situation has changed sharply since then. From the end of 2012 to the middle of 2017, Chinese net private wealth has climbed $7.3 trillion, annual growth never touching 9 percent. American net private wealth jumped $26 trillion. The American base was much bigger and American growth also became a bit faster. The result: mid-2017 Chinese net private wealth was $29 trillion and American net private wealth was over $93 trillion. The Federal Reserve supports the Credit Suisse number, putting American household net worth at $96 trillion.

Just as GDP is not the perfect measurement of economic performance, nor is private wealth. Neither provide information about growing global concerns about inequality. But wealth does reframe the U.S.-China discussion. Claims that China is about to eclipse the United States are untenable in the face of $64 trillion less in net private wealth. Claims that China is outpacing the United States are challenged by the private wealth gap widening by $18 trillion in the past four and a half years after widening by less than half that the previous twelve years. In terms of private wealth, China is barely visible in America’s rear mirror.

The Public Sector

Of course Credit Suisse could just be wrong about the PRC. And there are two more questions to raise. The first is whether U.S. dominance since 2012 reflects American stock and property bubbles being bigger than China’s property bubble, so that the gap will narrow when all bubbles pop. This is entirely possible, but will not matter much. Private wealth declines of the magnitude seen during the global financial crisis, for instance, would leave the U.S. $56 trillion ahead, the same-size gap as 2014.

The fundamental limitation of net private wealth lies in “private.” It is total national wealth which enables pursuit of national interest—the public sector must be included. This is not an easy task. The Party suppresses information on debt problems in the PRC’s huge banking system. The U.S. government’s evaluation of public-sector assets is questionable. However, U.S. federal debt and gross Chinese state assets are both very large, narrowing the wealth gap.

There are official Chinese data on state corporate assets that at least have been internally consistent for some years. These put mid-2017 gross assets at 145 trillion yuan and liabilities a bit over ninety-five trillion yuan, for $7.4 trillion in net state corporate assets at official exchange rates. However, there are strong incentives for state firms to overstate assets and understate debt. This corporate asset figure should be seen as a maximum.

Other public liabilities include central and local government debt. These are considerably smaller than state corporate debt—their official level was $4.1 trillion at the end of 2016. Beijing’s numbers for this have become suspiciously stable and a comparable Bank of International Settlements (BIS) number is $1.1 trillion higher at the end of March 2017, rising such that $5.3 trillion can be used as the mid-2017 estimate.

The biggest state asset beyond corporate holdings is land. It is generally difficult to assign value to large amounts of land because mass sales would cause prices to plummet. It is more difficult in the PRC due to the government’s distorting role. Data over time on revenue from land sales imply a very round value of state land assets of $3.7 trillion at the end of 2016. It is probably a bit higher by mid-2017, though sales are unstable.

This land value could be too low, just as corporate liabilities are probably too low. But the errors run against each other, leaving a rough estimate of public sector assets as adding $6 trillion to net private wealth. Chinese national wealth mid-2017 is therefore approximately $35 trillion, perhaps a bit higher.

On the American side, the main event is federal debt, $19.8 trillion in mid-2017. State and local debt added almost $3 trillion to that. Simple. The problem lies with assets, meaning property.

The federal government owns over 27 percent of all U.S. land while state and local governments push that above 33 percent. Estimates of the worth of this land run from less than $3 trillion for federal and local combined to more than $125 trillion for just federal (using dubious assumptions about commodities). The Federal Reserve puts U.S. government nonfinancial assets at $14 trillion in mid-2017, $10 trillion in state and local government buildings, so its figure for U.S. net wealth exceeds $88 trillion.. But selling those buildings would crush prices, implying a far lower present value.

An indirect calculation based on broader Federal Reserve real estate data yields $9.1 trillion in combined government assets mid-2017. This puts the American public sector position at negative $13.6 trillion and net national American wealth a little below $80 trillion. The wealth gap closes when the public sector is incorporated, but it’s still huge.

American Choices

Land value estimates are imprecise, at best. Asset prices mean wealth can shift sharply. The Credit Suisse private wealth data have been—and can again be—revised. But Credit Suisse, the U.S. Treasury, the Federal Reserve, the BIS, and even the Chinese government (with respect to state corporates and land sales) provide cohesive data over time.

The United States is nearly $45 trillion ahead of China in net national wealth. Further, the gap is not presently closing. It is not closing in private wealth in isolation, it is not according to BIS debt data, and it is not according to this calculation method which utilizes Chinese reporting. In this sense, faster Chinese GDP growth is revealed as somewhat meaningless, at least starting this decade.

If America chooses not to compete with China in East Asia or lead globally, then no wealth advantage matters. When and where we choose to compete, the resource advantage rests overwhelmingly with us, and it will for the indefinite future.

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Will Chinese Commodities Derail The Global Reflation Trade?

Leland Miller and Derek Scissors on why investor excitement over Chinese capacity cuts this winter is oversold, and the serious implications for the global reflation trade.

For over a year, commodities bulls have feasted on China. In the aftermath of the recent Communist Party Congress, many investors are now drooling over the prospect the boom will continue, based on Beijing’s promises to supercharge its campaigns against overcapacity and pollution this winter. If such pledges are fulfilled, the thinking goes, substantial chunks of steel, aluminum, and other refining capacity will be taken offline, rebalancing markets and providing rocket fuel to already frothy prices. 2018 could prove to be an even more amped-up version of 2017.

For over a year, commodities bulls have feasted on China. In the aftermath of the recent Communist Party Congress, many investors are now drooling over the prospect the boom will continue, based on Beijing’s promises to supercharge its campaigns against overcapacity and pollution this winter. If such pledges are fulfilled, the thinking goes, substantial chunks of steel, aluminum, and other refining capacity will be taken offline, rebalancing markets and providing rocket fuel to already frothy prices. 2018 could prove to be an even more amped-up version of 2017.

Not so fast. Investors are misreading what a winter of capacity or production cuts—an overlooked distinction—would truly mean for China’s commodities sector. Assuming the government follows through in its war on steel and aluminum capacity this winter—and since this campaign appears to bear Xi Jinping’s imprimatur, we expect as much—the effect could well be bullish for prices in the short run.

However, there is a danger in drawing more far-reaching conclusions, especially that commodities are primed for another banner year. In our view, previous efforts to cut net capacity have been illusory. If capacity is finally being cut this winter, there is still so much excess that production could survive unscathed for years. If, instead, it is production being cut for immediate environmental gains, it may simply re-emerge in the spring—all bets should be short-term. Any extended price rally relies on both the cuts being real this time and continued robust demand, despite the latter being increasingly unlikely.

To see this, investors should reconsider the fundamental question: What actually caused key commodities to rally in China over the past year? The official narrative implies a combination of sizzling demand and the government’s touted reductions in supply—a view widely accepted by markets. Take steel. The Ministry of Industry and Information Technology in late October declared the steel industry had already met its full 2017 target for cutting capacity 50 million tons, after reportedly meeting its similarly ambitious target for 2016. Critically, any distinction between gross cuts and net ones is glossed over.

Many traders accept this narrative because it accords closely enough with their own observations. For example, by 2017 Chinese iron ore imports had jumped to record levels and steel prices were rocketing skyward. Some high-profile capacity cuts were evident, such as those in Tangshan, China’s largest steel-producing city. Under these circumstances, the notion that Beijing had finally gotten serious in targeting excess capacity seems sensible.

Sensible, but not accurate. Our firm’s China Beige Book proprietary commodities survey, which includes hundreds of companies across steel, aluminum, copper, and coal, tracks capacity, production, and investment as reported by the firms themselves. Despite the fact that these firms have a very strong incentive to parrot the government story that they are cutting net capacity, for an astounding six straight quarters they have told us precisely the opposite. While some capacity has indeed been taken offline, as Beijing notes, net capacity rose from the second quarter of 2016 through the third quarter of 2017 in every one of these core industries.

The problem extends beyond capacity to production, specifically overproduction. In aluminum, for example, the percentage of firms reporting rising inventory has been at least 20 points higher than those reporting falling stocks in each of the six quarters. Supposed capacity cuts cannot mean much while inventory continues to pile up.

If not supply cuts, what explains the rally? For over a year, the counterpart to blistering demand has been speculative capital inflows. This is not unusual for China, as the “moneyball” at various times rolls into property, stocks, and bonds, as well. Here, it has kept commodities prices rising skyward for over a year. But, just as it has done with stocks and (recently) bonds, the moneyball also quickly rolls away when chosen markets lose their shine. If commodities demand weakens, investors relying on supply cuts will be exposed.

This could happen quickly. Many China bulls take comfort in the strong 2017 macroeconomic performance as indicating commodities demand will remain robust. In China Beige Book data, though, all four commodities sub-sectors showed substantial demand weakness in Q3, off what may have been a Q2 peak. While this so far represents just one quarter, not yet a trend, any extended slide will cause the moneyball to flee. Until genuine supply reduction becomes clear, there could be intense and sustained downward pressure on prices.

Chinese commodities, like the economy, remain in many ways a black box, so investors can be excused for holding to a government narrative. But there could be serious repercussions from taking government projections at face value. A sharp rather than slow commodities reversal, unexpected in the aftermath of the Party Congress, would reignite doubts about Chinese growth. It would also elevate questions over global growth. To the extent the commodities rally is important to global reflation, a sustained fall in Chinese prices would shake confidence elsewhere.

Recent behavior by various central banks suggests that interest rate hikes could also be held hostage to Beijing’s supply decisions. What happens in China no longer stays in China.

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Leland Miller on Pressing China Issues

The Epoch Times
Leland Miller, the founder of China Beige Book, spoke with The Epoch Times about which investors and companies are interested in China, the latest developments in the currency, U.S.-China relations, overcapacity problems, and the One Belt One Road Initiative.

The Chinese economy is strange in many ways. Not only is it a hybrid between private capital and state control, but very few people directly invest in the mainland — and yet everybody is interested in how the second largest economy in the world is going to develop. That’s because Chinese demand determines the prices of world commodities, and the operations of multinational companies in China impact earnings. When the yuan falls, markets across the world get jittery. China watchers accept the fact that official Chinese data is severely flawed, and often simply fabricated, yet they still use it to analyze the Chinese economy and markets because there are few alternatives. One alternative, however, is the China Beige Book International (CBB), a research service that interviews thousands of companies and hundreds of bankers on the ground in China each quarter. They collect data and perform in-depth interviews with Chinese executives.

Interviewed By Valentin Schmid, The Epoch Times
The Epoch Times: Who are the investors and companies interested in China and your services?

Leland Miller: There’s people who play the share roulette or people who have a specific company in mind. We see a lot of this in the retail space and they want to get more information from us. They invest in something where they think there is this untapped market either in China or as China goes abroad.

You’ve got macro firms who may not care about the day-to-day in China but want to make sure they understand the dynamics of China demand, of China credit, of China currency, so that they don’t get caught out.

Commodities are in incredibly high demand. We spend a lot of our time dealing with commodities firms now because we have all this data that’s not typically available. Things like net capacity, and a lot of firms have said, “Well, we have no way of checking government numbers…. If they say they’re cutting capacity, we have to believe them.” Well, we don’t believe them, we do it ourselves and what we found is that the opposite is happening across commodities, across time.

So you have all these different types of firms, but I think there is one uniting factor: whether they’re doing China micro, they’re doing China macro, or some niche element of the economy. If they don’t get China right, there are going to be repercussions in their portfolio.

So even people now who have absolutely nothing to do with China are clients of ours because as they keep abreast of what’s going on, they need to understand this and not get knocked from the side off their feet when they weren’t expecting it.

An increasing share of our clients are people who just want to understand China at the 30,000-feet level. Our early clients are people who want to understand at the 30-feet level. And we have everything in between, but also the corporates. The corporates have a very different mind-set: they need to know different things than, say, a hedge fund or other asset manager, who is simply trying to find a good trade.

The Epoch Times: How do you see the Chinese currency developing?

Mr. Miller: They took a very risky strategy on the currency dating back to last fall, and it worked. But it didn’t have to work and it may not have worked, and I think it’s worth looking back at this chronology because this could have been a very different year had some of this not worked out. Back in September 2016, the Chinese started to understand that there was a very real chance that the Federal Reserve (Fed) was going to hike in December, and they needed to prepare the currency and prepare themselves for a rate hike.

They started doing that and they weakened the currency. And then when President Trump was elected, they said, “Okay, well, we got to do this even more. We have to weaken right up until he gets elected so that we can come back and say we’re going to strengthen it once he gets elected.” Now it’s a very cynical strategy that happened to work, but what’s interesting is that there was an enormous amount of commentary late in 2016, early 2017, about how — and we see this all the time — now that China is pegged to a basket, it’s not pegged to the dollar, and that the Chinese have made this move.

That is just not correct. They had not switched, there has not been this back-and-forth. The yuan is essentially pegged to the dollar. The seven handle on this, the seven yuan to the dollar is extremely important for a lot of reasons, most importantly the politics around this, the politics with Congress, the politics with Trump, the politics with the Chinese leadership.

And the idea of them creeping closer and closer to 7 was a real major problem. They understood that this was a politically charged number and they got real close to it and they timed it well and they backed off it, and it had been strengthening ever since which has been supported by the fact that the dollar has been in a weakening trend.

But the interesting thing here is they figured out, “We’re going to give Trump little rationale for letting him say we are a currency manipulator. But right up until that point, we’re going to keep weakening, and we’re going to hope that nothing bad happens.”

Shockingly, they got up to 6.9 — it was approaching a danger point where I think markets would have started caring, and they backed off at the right time. So they have had the 2017 best case scenario, they haven’t had these interruptions, they haven’t had a super strong dollar that a lot of people thought was going to happen six months ago.

So the yuan is not on the top of people’s worry list right now but it’s just a matter of time before they have to deal with these dynamics again, unless the dollar is in a long term weakening trend.

The Epoch Times: How do you see U.S.-China relations in the future?

Mr. Miller: The administration understood that China’s a radioactive word if you use it politically, so we’re going to fight back on China, we’re going to save American workers from the tyranny of Chinese goods. That was the calling card for a while. And then of course President Xi and President Trump met at Mar-a-Lago and had this beautiful chat and everything turned around.

President Trump was convinced to give the Chinese some amount of time to fix the trade problem and fix North Korea and a whole bunch of other things. A lot of really smart China watchers have been saying recently that the President is angry that the Chinese have not done what he wanted them to do on the trade side of North Korea and he’s flipped and you’re about to see the repercussions.

I would actually push back against that. I think that what you’re seeing right now is a gradual dissatisfaction with this. But the real tea leaf here will be the South China Sea. The U.S. position in the South China Sea has just been invisible for the most part. I mean, they talk about a few spy ops but they have been mostly invisible for the past six, seven months.

And when the President, the White House, the administration makes this turn and decides: “Alright, China is not going to help us out, we now need a stick and we need a big stick,” you’re going to start seeing developments in the South China Sea. The fact that there has been some push back on trade, the fact that we’re talking a little bit about steel, it’s totally misunderstood.

The steel measures being talked about are not anti-China, although they’ll be sold as that. So I think we need to stop jumping the gun on the idea that the president has turned hostile on China. This hasn’t happened. Do we think it will happen? Yes. I think it’s a 2018 thing. But I don’t think that there has been a major shift in policy.

The Epoch Times: Are the Chinese really tackling the overcapacity problem?

Mr. Miller: There are two stories here. The first is what our data is saying and the second is the mistake I think a lot of investors make in seeing commodities as monolithic in China.

People usually think that they’re either going to cut capacity across the board or they’re not going to cut capacity at all. So what we have been seeing is not cutting capacity. When prices have gone up, a lot of investors said, “Look, the Chinese government is making good on their pledges to cut capacity. Look at prices are going up, imports are going up.” Anecdotally, that suggests they’re cutting capacity.

Now, they are cutting gross capacity, but total capacity added has gone up every quarter and it’s gone up in almost every sub-sector every quarter. They are adding capacity, and this is very intuitive if you think about it. There are all these industries who used to laugh about the economic reports we used to get from these firms quarter after quarter after quarter of higher inventories, worse revenue, no profits, more capacity — it was just a joke.

Now all of a sudden they’re getting this good economic scenario and they are not about to cut back. It makes sense that they’re not cutting back, but the narrative on this is that the Chinese government is hard at work cutting capacity, and it’s totally a mistaken narrative. Now, we tracked this very closely across coal, aluminium, steel, and copper, and there is a very clear dynamic there and it’s been clear for the last year plus. They are not cutting net capacity.

Now the other issue here is the differences between sub-sectors. When you look at coal and when you look at steel, there’s a different long term concern about the two of them. With all these Chinese commodities, there’s potential overcapacity issues, but coal kills people and coal turns people’s lungs black.

And so the idea that the Chinese can continue to crank out coal the same way they can crank out steel, with the same repercussions, it’s not there. So over time I think we will see a pullback on the coal side. It’s an open question as to whether we’ll see it in steel and aluminum; a lot of this might be affected by the trade actions coming out of the United States, but right now the major story here is that investors are guessing.

They’re guessing based on prices and they’re getting this wrong more often than not. They don’t understand the degree to which these sub-sectors are cutting back. In fact, they increasing capacity, they’re bringing more capacity online. They take the old ones and take them offline or the ones that aren’t being used, but they’ll activate others or they’ll build others or they’ll upgrade others. So the overall dynamic is that more capacity is being brought online but then make a very big show of what they take offline or what they blow up.

They used to put TNT into giant iron plants and blow them up to show that the government was doing something. This is the equivalent of this in 2017. But net net, they’re not cutting back right now. They’re trying to take advantage of a good market for their goods and so this is going to shock people. It’s already surprised people; that’s why you see these enormous 5 percent, 8 percent moves in a day on these commodity markets. But it’s going to shock people more going forward when they understand the totality of what has happened over the past year.

The Epoch Times: What are your thoughts on the One Belt One Road (OBOR) initiative?

Mr. Miller: What is the real goal for this? The goal is to exert Chinese influence abroad, it’s to recycle surpluses in goods and services abroad to some degree because of oversupply. It will accomplish certain things but is it a worthwhile project? Is it going to do what everyone thinks it’s going to do? No, of course not.

But there are things being done. It is a project large in scope, it will attract headlines for many years, but at the end of the day is this a game changer for China? No. Have the Chinese ever in any context found a sustainable ability to get returns, to get an actual return on their investment? No. And they’re going into a situation where they’re irritating a lot of these states who think that they were going to be able to use their own labor, but the Chinese are using Chinese firms who are doing quite well so far, and having them do the labor.

There are political problems that brings up. They also have a different situation right now than they did three years ago when you talk about the Forex reserves in the capital accounts. So the idea that they had too much and had to figure out ways of dumping Chinese capital in other places, that problem has reversed itself. Now we are not at any kind of problematic point at around $3 trillion, people have the opposite concerns. I think that if this were not a President Xi initiative that he has attached his name to, this would have been deescalated far more dramatically.

They’re going to have to build it up, it still plays a role, it’s still worth watching, but the idea that this is a real game changer similar to the Asian Infrastructure and Investment Bank which was a political upheaval about a year ago, two years ago, whenever it was, these are not game changers. These are Chinese inefficiencies at work abroad.

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