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U.S.-China trade dispute: Will China Weaponize the RMB and U.S. Treasury bonds?

April 10, 2018
Bob Savage
Track Research

U.S.-China trade war: collateral damage

Consider the soy bean. 'China is threatened retaliatory tariffs on U.S. soybeans. The U.S. is one of the largest producers of soybeans. If China's not going to buy them, we're going to have an excess capacity.'

  • 'So, last week, we saw a soybean selloff.'

'But there was a complete dislocation in whole soybean supply chains. Downstream products, like soybean oil, didn't move at all in the same way.'

1. Will China Weaponize the RMB and U.S. Treasury bonds?

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‍Source: Reuters                                                                                                                                                                                                          

Bob Savage of TRACK says: 'In its talks about tariffs with the U.S., China appears to be discussing - in addition to, of course, to preventing other U.S. goods from coming in - two retaliatory measures to persuade the U.S., "You don't want us to do this,"':

  1. 'Devaluing the RMB'
  2. 'Selling U.S. Treasuries.'

1. Devalue the RMB. Devaluation is 'one quick way of making up for how tariffs hurt you.'

  • 'But, that currency movement could be very ugly if the Chinese wanted it to be.'
  • 'If China destabilized its currency, this would wreak havoc on the order of inflation and cause even more market volatility.
  • 'In the end, 'the aims of the U.S. tariffs would backfire.'

But, for China it would also create, 'plenty of new problems, so China would not to want to do that.' Devaluation would:

  • 'Promote the idea that there's an outflow of capital.'
  • Panic markets. 'Destabilizing the RMB could panic some of the money that has been found a home for the rich Chinese in their stock market, or in their property market, or even in the nascent bonds market.'
  • Cause a round of devaluations. 'If China's devaluing its currency, other countries are going to have to devalue their currency.'
  • And, 'destabilizing the currency reverses a lot of the goodwill that Xi is trying to promote with the rest of the world.'

2. Selling U.S. Treasuries. 'As we know, China is one of the largest holders of the U.S. Treasuries [see the chart, above].

  • 'And, in China, there has been open discussion, even before the proposed tariffs, as to, "Why are they investing in those Treasuries?"'
  • Some argue, 'Treasuries are not really doing a lot for China other than being a placeholder for U.S. dollars.'
  • 'One Chinese government adviser this week even talked about selling Treasuries and investing more in 'One Belt One Road' or in other ways that help the rest of the world.'

Higher U.S. interest rates. 'If China sold even a tenth of its bonds, interest rates on the benchmark U.S. Treasury 10-year bond could inch beyond the 3% level.'

  • With the annual U.S. budget deficit about to top $1 trillion and the Fed pulling back, this would create a bearish bond market, pushing U.S. borrowing costs higher.

But, as rates sharply increased, the value of China's remaining Treasuries would, in turn, tank, and China would lose billions.

2. Markets whipsawed...consider the soybean 

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Both China and the U.S. are clear about they want from their respective trade agendas. Bob Savage of TRACK says:

  • For China, 'more U.S. exports of intellectual property wrapped around technology.'
  • For the U.S., 'a much smaller trade deficit with China, spurred potentially by selling them more cars, maybe a little bit more commodities, and a lot more junk, like U.S. movies or other intellectual property. And, we would love to have Fidelity, or BlackRock, and Goldman have offices all over China.'

'Those things are going to take a lot of time.'

  • 'In the interim the markets are moving up and down on every release about whether the trade discussion is going well or not.'

Consider the soy bean. 'China is threatened retaliatory tariffs on U.S. soybeans. The U.S. is one of the largest producers of soybeans. If China's not going to buy them, we're going to have an excess capacity.'

  • 'So, last week, we saw a soybean selloff.'

'But there was a complete dislocation in whole soybean supply chains. Downstream products, like soybean oil, didn't move at all in the same way.'

  • Why? 'Because the talks are going on and off so quickly. One day we're talking to each other, and the next day we're threatening each other.'
  • 'So the truth is, you have an order for soybean oil, it doesn't matter:  you have to deliver it, and you can't short that stuff.'
  • 'The fact is, to fill the orders, you're going to need soybeans to make soybean oil, so all you're doing is creating windfall opportunities for these processors to take some of these commodities and play off of them.'
  • 'Eventually, the net result is going to be inflation.'

'This highlights the problems with a market that's speculating on the success and failure of the bravado of two big countries talking loudly to each other about what they want in their trade agendas.'

3. U.S.-China trade war: collateral damage

Bob Savage of TRACK: 'My favorite saying relating to the trade dispute is an African proverb, "When elephants fight, it's the grass that suffers."'

  • 'When powerful nations are conflicted, the weak ones suffer the most, so it goes for the market reactions to the US and China rumpus over trade.'
  • 'The countries that are going to be hurt most by a prolonged U.S.-China discussion about trade, leading perhaps to even more minor skirmishes over tariffs and tit-for-tat actions are emerging Asia and many of the allies of the United States.'

'So, the rest of the world is looking less sure and less happy over the fight. There are unintended consequences to this U.S.-China squabble because trade reflects the integration of global businesses into a complex supply chain.'

'German carmakers are an example of losing out.'

'Germany exports cars to China, but most of them are German-branded cars made in the United States.''So, Germany would be hurt almost immediately if China slaps tariffs on U.S. autos.'

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'The two biggest losers are Canada and Mexico thanks to NAFTA.'

More losers: 'Korea and Japan are deeply integrated into the manufacturing processes in China of high-end consumer products like smartphones.'

  • 'They export, for example, integrated circuits that go into products like smartphones.'
  • 'China then assembles the imported parts into finished products.'
  • 'And, these products are shipped to the U.S. as 'Made in China.' 

'This is the outcome of bilateral trade disputes in globalized world economy.'

  • 'We're far more developed than the mercantile world of the 15th and 16th centuries.
  • 'And that's why economists are up in arms - we're well beyond this.'

4. Beyond trade

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‍'Those who cannot remember the past are condemned to repeat it.' George Santayana.  

'Economists have been arguing against trade wars since the 1930s.

  • 'The fear of a further rise in protectionism is a clear downside risk to global growth and an upside risk for inflation.'
  • 'We may be forcing the Federal Open Market Committee (FOMC) to respond to U.S. loose fiscal policy and tighter labor markets with rate hikes that also reflect a splintering of the global trade rules set after World War II.'

'This rumpus isn’t a child’s game even though it appears to have a tit-for-tat quality to it.'

  • 'Beyond trade fears remain real economic doubts as the push for growth to drive up inflation hasn’t been convincing in places where demographics, technology and excess capacity hold (Japan, Europe, and some Asian Emerging Markets like Korea).

'The other geopolitical stories have taken a backseat to the headlines but perhaps will show up in markets again with...

  • 'Hungary re-electing nationalist Orban as PM – highlighting the ongoing splintering of EU politics.'
  • 'Syria continuing with gas attacks – highlighting the inability of the world to control war crimes or bring peace with a corrupt leader.'
  • 'Hamas continuing with protests in Gaza.'
  • 'Germany suffering another terror act as a van plows into a crowd in Munster..'

'Perhaps the most important story from last week and for the week ahead is in the fear for markets – it’s reflected in US stocks, not in bonds or foreign exchange (FX).'

  • 'The lack of FX reaction to the ongoing political noise is notable but understandable in the context of 2016-2017 when central bankers successfully counteracted political events like Brexit or even the election of Trump.'
  • 'Whether that continues maybe the key to understanding risk events for the rest of April and for 2Q.'

'It requires a great imagination to hope that this all ends well. I'm not sure it will. But, until then there are two things that we're going to have':

  1. 'Increased volatility in currencies, especially in emerging markets' and 
  2. 'Increased nervousness over interest rates.' 

5. Sort of surprising U.S. & China trade numbers

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‍Source: Reuters

Bob Savage of TRACK: 'The trade war theme is still far more in the front of traders and investors fears than some larger conflagration in Syria.' 

'U.S. total trade deficit up $57.6bn – worse than the $56.5bn expected.'

  • 'But, China's trade surplus with the US fell to $15.43 billion, below the $20.96 billion level of February.

'The China trade data today was the big release with exports lower and imports holding.'

  • 'China March trade flips to deficit of $4.98bn after surplus of $33.75bn – worse than +$27.2bn expected – first deficit in 13-months.'
  • 'Imports up 14.4% year-on-year;  exports fell 2.7% over the same period.'
  • 'Most of this can be linked to the noise of the Chinese New Year.
  • 'But not all. 'China is in the midst of its own transformation from investment led growth to domestic consumer focus.  This isn't about trade tariffs but the needs of the Chinese people.'  
Bob Savage

Bob Savage

Chief Executive Officer
Track Research
  • Chief Executive Officer, Editor-in-Chief and Head of Research of Track.com
  • Joined FX Concepts as COO and Chief Strategist when Track.com was acquired by FX Concepts in 2012.
Track Research

Track Research

Trackresearch.com is the global marketplace for research ideas. It is a place where qualified contributors can share their stock, commodity and macro ideas with a unique group of institutional investors, high net worth individuals and other thoughtful market participants.

We are an independent platform for investment research and market ideas. Our content is submitted by highly qualified professionals with proven track records and a developed understanding of what is required to produce thoughtful research. We offer our contributors a unique distribution channel to a growing base of institutional money managers in search of top-quality, real-time research, as well as the general public. We provide filtering, messaging and alerting tools so that our readers can access what they want as soon as it is available to them.

Our management team has over seventy years of experience in financial services at top tier firms.

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Track Research

U.S.-China trade dispute: Will China Weaponize the RMB and U.S. Treasury bonds?

Bob Savage
Bob Savage
4/10/18
U.S.-China trade dispute: Will China Weaponize the RMB and U.S. Treasury bonds?

U.S.-China trade war: collateral damage

Consider the soy bean. 'China is threatened retaliatory tariffs on U.S. soybeans. The U.S. is one of the largest producers of soybeans. If China's not going to buy them, we're going to have an excess capacity.'

  • 'So, last week, we saw a soybean selloff.'

'But there was a complete dislocation in whole soybean supply chains. Downstream products, like soybean oil, didn't move at all in the same way.'

How Trump's tariffs impact China's trade/currency relations with Japan & Korea

How Trump's tariffs impact China's trade/currency relations with Japan & Korea

'The currency markets are embroiled in trying to figure out whether the Trump tariffs on steel and aluminum are good or bad for the U.S. economy and the U.S. stock market.'

China's RMB oil futures exchange—the 'story of the year'!

China's RMB oil futures exchange—the 'story of the year'!

There's a lot to follow in China. And, I had missed reports about the opening of the Shanghai International Energy Exchange or INE, likely this quarter. But, during my interview with Bob Savage, the well-respected analyst of global markets and CEO of TRACK, he told me the INE could be the 'story of the year.' That's a big - and interesting - claim about something that seems like one more ho-hum Chinese entity. Bob explained that the INE will create the an RMB-denominated oil futures contract. The first such contract in a petrodollar world, where China is largest crude oil importer. If RMB oil contracts - even just for trade with China - catch on, then the whole global oil trading regime will change. And, given the massive size of the global oil trade, a shift from dollars to RMBs will both erode the dollar as a reserve currency, and push the RMB closer its goal of becoming a full reserve currency.

China's trade surplus up, RMB weaker

China's trade surplus up,  RMB weaker

'The RMB did not like the trade data at all, and it weakened immediately - over 1% today.' 'Overnight, the world has moved a little bit away from its U.S.-centric obsession about equity volatility in the United States and around the world to what's going on in China,' says Bob Savage, CEO of TRACK and member of the soon-to-be-launched China Analyst Network.

Bob Savage

Bob Savage

Chief Executive Officer
Track Research
  • Chief Executive Officer, Editor-in-Chief and Head of Research of Track.com
  • Joined FX Concepts as COO and Chief Strategist when Track.com was acquired by FX Concepts in 2012.
Track Research

Track Research

Trackresearch.com is the global marketplace for research ideas. It is a place where qualified contributors can share their stock, commodity and macro ideas with a unique group of institutional investors, high net worth individuals and other thoughtful market participants.

We are an independent platform for investment research and market ideas. Our content is submitted by highly qualified professionals with proven track records and a developed understanding of what is required to produce thoughtful research. We offer our contributors a unique distribution channel to a growing base of institutional money managers in search of top-quality, real-time research, as well as the general public. We provide filtering, messaging and alerting tools so that our readers can access what they want as soon as it is available to them.

Our management team has over seventy years of experience in financial services at top tier firms.

THE TRACK FREE TRIAL

THREE SUBSCRIPTIONS LEVELS,ONE TO SUIT YOUR NEEDS

With the TRACK FREE TRIAL you can try out our prestigious PREMIUM SUBSCRIPTION for 2 weeks and our BASIC SUBSCRIPTION for 1 week. Once the 3 week trial period is over, you will have limited access to TRACK for an unlimited time at the FREE REGISTRATION level.

SIGN UP TO START YOUR FREE TRIAL

Channels

AsiaStrat
Granite Peak Advisory
Track Research
Trivium China
Gao Feng
Real Estate Foresight
China Beige Book
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