What really makes China so scary today is the fact that it has so many people, and it’s also becoming an incredibly wealthy country so that our great fear is that China will turn into a giant Hong Kong. And if China has a per capita GNP that’s anywhere near Hong Kong’s GNP, it will be one formidable military power. So a much more attractive strategy would be to do whatever we can to slow down China’s economic growth— because if it doesn’t grow economically, it can’t turn that wealth into military might and become a potential hegemon in Asia.
University of Chicago Professor John Mearsheimer. As quoted (approvingly) in Peter Navarro’s Crouching Tiger: What China’s Militarism Means for the World
Right now the markets are abuzz with happy talk that US and Chinese officials are holding productive discussions on trade issues and that a US-China trade war will be avoided. My view: this is great and certainly the most rational outcome — but don’t break out the champagne yet.
The global acceleration of technology presents a tremendous investment opportunity. But opportunity could have a problem if the most powerful man in the world — the President of the United States — due to not so subliminal anti-Chinese fears, could be hell-bent on disrupting the global integration of technology, and by implication its acceleration. Perhaps this is a misrepresentation of the American President who enjoys out-bluffing his opponents. We can hope.
Judging Trump by the views of his advisors can be dangerous. Still, it’s hard to not take seriously the views of his influential advisor, Peter Navarro or the just appointed John Bolton. The Mearsheimer/Navarro quote above sums up what I think is the real Navarro strategy (which I suspect Bolton shares): KEEP CHINA POOR SO IT CAN’T THREATEN THE US MILITARY DOMINANCE IN ASIA. It’s hard to believe Navarro deep in his heart shares Trump’s atavistic obsession with old school heavy industries like steel and aluminum. No, what Navarro really wants is to hurt China even if this means hurting the American economy. For example, in his book Navarro cheerfully admits that protectionism vis-à-vis China will raise prices for the American consumer. No problem — so long as the protectionist measures hurt China more.
Navarro’s real goal is to slow down China’s military and technological ascent. The recent hiring of John Bolton as National Security Advisor is a very bad sign. It suggests that Trump shares Navarro’s views which are as much military as economic. Bolton is a super hawk who needs no introduction and whose publicly expressed views fit right in with Navarro’s. He may be considered the spiritual heir of the infamous General Curtis LeMay who specialized in fire-bombing Asian civilians and who happily admitted he would be arrested as a war criminal had America lost the war with Japan.
Made in China 2025 – A Red Flag for the Trump Team
In previous blogs, I have discussed China’s Made in China 2025 plan which sets forth China’s ambitions in technology. This is a top-down state-directed program to make China number one in such fields as semiconductor chips, artificial intelligence, aircraft, biotech and driverless cars. One can be skeptical that such a top-down approach will use capital as effectively as a more bottom-up American style market driven one. For example, industry commentators such as IC Insights have expressed skepticism that China’s simply throwing money at building semiconductor memory plants can overcome its lack of technological expertise and the wall of patents held by Western companies like Micron (MU) and Samsung (5005930.KS). But Made in China 2025 fits into the overall protectionist Chinese economic model and the Chinese fondness for state-directed great leaps forward.
Efficient or not, Made in China 2025 is a red flag waved in front Trump and his team. Technology is dual use — civilian and military. A vision of multitudes of techno-assisted Han warriors threatening America’s military dominance must flash before their eyes.
America has legitimate reasons to insist on a reduction in Chinese protectionism and an increase in market access for Western firms. It’s possible that Trump — as master of the deal — is threatening a trade war to achieve reduced Chinese protectionism and improved Western market access. So in the end, he will work out a reasonable compromise with China and the world will live happily ever after. But is it also possible that this hides the real “keep China poor” objective? China may never concede enough to please Trump and Navarro because their real objective is continued American military dominance.
One bad sign. Trump is reportedly planning to limit Chinese tourists and Chinese students to the United States. That’s a hurt-China measure that will worsen the American balance of trade. Tourism and education are American exports. Why does Trump want to curtail American exports?
Two Dumb Things from History
American presidents can do a great deal of economic damage when they impose measures that deliberately harm the economy. Two events stand out. The first is the Embargo of 1807 enacted by President Thomas Jefferson to keep the US out of the Napoleonic Wars. American commerce with Britain and France ceased, American ships rotted at the docks and the effect on the American economy was, in the opinion of historians, catastrophic.
The second “dumb” episode was President Kennedy’s imposition of the Interest Equalization Tax in 1963. This tax, which didn’t really do much for America’s then balance of payments problem or New York’s status as a global financial center, wasn’t removed until 1974. Foreign stock purchases for example had a 15% tax placed on their price of purchase. Today, American institutions and retail investors have major investments in Chinese ADRs.
Just imagine if a 15% tax were imposed to discourage Americans from investing in China. Perhaps the Chinese see this coming. The Chinese apparently are already thinking of luring their big companies like Alibaba (BABA) to come back to China and list there. Too bad for American stock exchanges and American investors.
China Is No Angel
It has to be said that, besides having its protectionist strategy, China is doing other things wrong. China is rapidly building up its military capability and has built seven bases on artificial islands in the South China Sea. Moreover, China is building a string of bases in South Asia in Sri Lanka, Pakistan, Djibouti and now the Maldives. Its approach to its neighbors has at times been that of a bully and not that of a benevolent hegemon.
The Chinese build in military capabilities has been compared in Navarro’s book and elsewhere with the Kaiser’s build-up of the German navy pre-1914. Germany thus threatened the Royal Navy whose superiority the British felt was necessary for the preservation of their Empire. We all know that ended with the destruction of Europe and its empires and with millions dead. In 1914 Europe ruled the world. By 1945 Europe was financially and morally bankrupt. And this despite Britain and Germany sharing a common Christian European culture and their respective monarchs descending from the same grandmother. In 1909 Norman Angell published a book called The Great Illusion in which he argued a general European war could never happen because the results would be such a catastrophe. He was right about the catastrophe part.
China and the US do not share a common history or common grandmothers. It would seem the possibility of misunderstandings are greater than in 1914. And the toys the militaries play with today are infinitely more lethal. Navarro and Bolton and possibly Trump seem to want a high testosterone approach of more military spending and a weakened China policy. History shows that policy ends in disaster.
From an investor viewpoint, the last thing the world needs is an American president provoking a global recession so as to weaken China. Hurt China and American companies are hurt and the American stock market goes down.
For example, Apple (AAPL) iPhones are all assembled in China. Over 200 companies from a number of nations including Taiwan, Japan, the US and China supply the parts. Apple designs and markets the phones and makes a fortune — much more than their suppliers. But supposedly Apple phones —and that’s the whole phone and not just the part attributable to Chinese value added — are going to be considered a Chinese export. Trump logic would suggest a tariff will be placed on the import of Apple phones into the US. If that really happens, Apple becomes the new Big Short.
Actually, Apple phones aside, in the high tech area China is not a big exporter to the US. Instead, China is a big importer of high tech imports from Western companies. In 2017 Chinese electronics company ZTE (0763:HK) had to pay a huge fine for violating US restrictions on selling to Iran. US companies Qualcomm (QCOM) and Micron supplied essential semiconductor chips to ZTE and the sale of these chips to ZTE had been banned by the US government. Many observers believe had the ban not been lifted, ZTE would have been OUT OF BUSINESS.
So if the US really wants to hurt China it can a la Jefferson embargo US high tech exports to China. Of course that would cripple a number of US tech companies. They and their stocks would rot at the docks.
Chinese Holdings of US Debt Are A Problem for Everybody
China is a major holder of US Treasury securities. Some have made the argument that China can hurt the US by dumping its US Treasury position. In my opinion, nothing could make the Trump, Navarro and now Bolton triumvirate happier. China dumps its US Treasury holdings and has to convert the dollars into renminbi (what else can they do with them). Then the renminbi rises against the US dollar. Just what Trump wants — a more expensive Chinese currency. And there’s a political benefit. Trump can then get on his twitter pulpit and paint China as being irresponsible. Trump’s base will love it. Hopefully China will not go down the dump-Treasuries road.
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