“No China Trade Deal Until 2020, Maybe 2021…Maybe Never”
Mike Gleason: Trade tensions with China have been one of the big stories in the financial press for the past year and a half. We’ve seen U.S. equity markets gyrate up and down. One day traders are euphoric on rumors that a deal with China will soon be reached. The next day, they’re depressed over news of escalating tariffs and some other negative developments. Most recently, we saw a big rally in the stock market on the announcement that some tariffs will be delayed by a few months, although with the further inversion of the yield curve here today, the day we’re talking, Wednesday, the stock market is giving pretty much all of that back. But that aside, I’d like to start by getting your assessment of the prospects for a trade deal here, Gordon. Do you think we’re going to see these tensions resolved in the next few months?
Gordon Chang: Certainly not. I don’t see a comprehensive trade deal until 2020, maybe 2021, maybe never. Problem is Xi Jinping, the Chinese ruler, doesn’t necessarily want a deal. He owns this trade war, quote-unquote, and if he makes significant compromises, he’s going to accept the political responsibility for that. You’ve got to remember that accumulating great power is of course an advantage, but it means he also accumulated great accountability. He can’t blame other people. So I think that the Chinese political system right now is pretty much frozen, and that means we’re not going to see a comprehensive deal. We’re probably not even going to see an interim arrangement, either.
Mike Gleason: President Trump has been confident that the U.S. has the upper hand in trade negotiations. He believes China needs the U.S. more than we need them. Frankly, we don’t know if the president’s assessment factors in America’s largest export to China, that being U.S. dollars. We export an awful lot of inflation to China and might be ignoring the vast quantities of U.S. treasury debt they hold. So, it appears as though China does have some leverage here. There is also some political leverage. They certainly know how eager the president is to avoid a recession between now and the 2020 election. On the other hand, it would be hard to overestimate how important exports to the U.S. are to the Chinese economy. What are your thoughts about who is holding the stronger hand here? All right, so who has the upper hand?
Gordon Chang: The United States has the upper hand. You look at all the metrics, and they point in our direction. So first of all, we’ve got the larger economy. Last year, we produced $20.5 trillion of gross domestic product. China claimed $13.82 trillion, but that number is probably exaggerated. Also, we don’t have a trade dependent economy. Everyone wants the U.S. market, and indeed, China is dependent on us. They’re the trade surplus country. And we know from history that it’s the trade surplus countries that get hurt in trade wars, and China is extraordinarily dependent on us.
Last year, China’s merchandise trade surplus with the U.S. accounted for 119.3% of their overall merchandise surplus. That gives us enormous leverage over Beijing. And by the way, Mike, we’ve got a robust economy. We grew 2.1% in the last quarter. China, who knows what they grew, but probably half of what we did at best. And they could have even been contracting the numbers from China, especially the last couple months. The underlying indicators look particularly gruesome. So overall metrics, we’ve got them.
The only issue is political will, and people think that Xi Jinping, the Chinese ruler, has got more of it than we do. President Trump is doing a pretty good imitation of someone who thinks he’s got political will. So, I think for the moment, we can say that the U.S. is going to be safe. There’s going to be a lot of squawking, but Trump doesn’t seem to care too much, and long term, we’re just in the position where we can push the Chinese around. All we have to do is realize that we can do it.
Mike Gleason: Certainly Trump has built up a lot of his credentials as a successful businessman, as a good negotiator, so obviously we do have to keep that in mind. Do you envision China continuing to devalue their currency or are starting to dump dollars to hurt the U.S. bond market? Do you see them pulling something like that or will they just talk about that and use that as a threat, as a negotiation tactic, but won’t actually follow through… what are your thoughts there?
Gordon Chang: I’m not particularly worried about China dumping U.S. treasury obligations to hurt us because we got to, first of all, remember they’ve only got, what, $2 trillion at most in a very big and liquid market, but also, just think about the way the dynamics of the markets work. 100% of our obligations are denominated in dollars. So, the Chinese are going to get dollars and then they’ve got to put them into other currencies in order to hurt us, euros, pounds, yen, whatever, which means that Brussels, London, and Tokyo have got to go out in the global markets to bring their currencies back down in value because they’re going to soar when the Chinese buy them. So, these central banks have got to rebalance their currencies and the only way they can do that is to buy dollars. The Chinese have been talking about the nuclear options since the middle of 2008 but they never do it. And the reason they never do it is because they know it won’t work.
Mike Gleason: Getting back to the Chinese economy, over the years, it has been really hard for U.S. investors to get an accurate picture of what is really happening. We’ve all heard about the massive economic growth there, but then there are conflicting stories. We hear that growth is artificial. Many ghost cities have been built, and China’s economy is a massive bubble which could pop any time. You’ve been one of the strongest voices warning of troubles ahead over there. Recently, you appeared on Fox News and noted the Chinese are doing, “Some things which smell desperate.” Can you share with our listeners what you’re seeing there?
Gordon Chang: Yeah, if you look at, for instance, the numbers from June and July, they show imports are consistently down month after month and that shows weak demand. Car sales, which are bellwether, they were off for 13 straight months in July. You’re starting to see, for instance, urban unemployment increase, and some of these numbers which are supposed to be strong aren’t.
So, for instance, the purchasing managers indices for the manufacturing sector had been flashing negative, both the official one and the unofficial one. Industrial output in July was very low, the lowest in about 17 years or so, something like that. So, we’re seeing an economy right now that is in trouble. You go back, for instance, to December of last year, you had a professor at Brandman University in Beijing. He created a sensation across China when he said, “Look, the economy in 2018 is going to grow no more than 1.67%. It may even contract.”
Now, Beijing reported 6.6% for the year, but they’re not acting as if they’ve got an economy growing that fast. And by the way, even if they were growing at 6.6%, they’re creating an amount of debt which is about five and a half times more than they’re producing nominal GDP. They can do that for a little while because they control borrowers, lenders, courts, everything. But they can’t do that for very much longer. So, I think that they realize they’re in trouble right now and they just don’t know how to get out of it. When their default position is to just sort of spend more government money, but with the debt accumulating the way it is, I don’t think that they can do that for too much longer.
Mike Gleason: We’ve recently seen demand rising for gold and silver, including physical bullion. There are a number of reasons, some good price performances helping, but some of the demand is coming from investors who are increasingly skeptical about the U.S. equity markets, the dollar and even bond prices. As we’ve discussed, the trade dispute with China is one of the wildcards. Another is the risk that the Chinese economy will falter. Back in the summer of 2015 when the Chinese market was plummeting, it was a very rough time for stock markets all over the world. So, we have some recent history to go on there as to how important the Chinese economy can be to the rest of the globe. So, let’s about that one. What do you think it will mean for the U.S. if the bubble in China finally does pop, Gordon?
Gordon Chang: I think people are going to be taken by surprise. I don’t think they should, but they will be because markets do believe that China is growing somewhere close to the reported numbers. But we’re starting to see a rush to safe havens, and especially the 10-year Treasury. People want it, and that’s a real sign that there are problems in the global economy. And of course, China is going to exacerbate that. So, I think long-term, I would imagine that there’s going to be a flight to safe haven and when the Chinese economy does hit the wall, it’s going to be very good to be in 10-year Treasuries, in gold and other safe haven assets.
Mike Gleason: Well, as we begin to close here, Gordon, any final comments that you want to leave us with today? And I didn’t ask you much about North Korea, so maybe give us your thoughts on the developments there and other geopolitical theater that you’re going to be watching over in Asia in the coming weeks and months that investors might want to be thinking about and keeping an eye on.
Gordon Chang: I think the most important thing in terms of geopolitical developments in Asia to watch in terms of effect on financial markets is going to be the situation in Hong Kong. Hong Kong is irreplaceable as a city, but we’re seeing a hardening of attitudes on both sides. You’ve got not only the pro-democracy kids, but you’ve got a big portion of the Hong Kong population, at least two thirds, maybe three quarters, that are supporting the kids because they believe that this is the last stand for autonomy. And because of that hardening of attitudes, I think you’re going to see both sides take positions that probably are going to end up shaking not only the Hong Kong markets, but global markets as well. North Korea, at least for the moment, is a side show. Hong Kong is where we really need to look to get our clues to where things are going.
Mike Gleason: Obviously, a lot of us have seen what happened there this week just on our TV sets about the riots in Hong Kong. Just lastly, what’s your take on that and do you think we’re going to see more of that sort of thing as the unrest grows?
Gordon Chang: Normally, you would think that demonstrations would just sort of lose their vigor and they sort of melt away, which is what happened in 2014 with the occupy protests. But these protests have been actually going on since April. We’re now in our 11th straight week, and they show no sign of stopping. And it’s because I think people believe that this is the last stand. So, there’s going to be difficulties ahead. I don’t think that the Beijing is going to deploy the People’s Armed Police or the People’s Liberation Army into Hong Kong at least until after October 1st, which is the 70th anniversary of the founding of the People’s Republic, but sometime after that, I’d be very worried that China is going to do exactly that.
And by the way, Mike, we have had video evidence suggesting that mainland police officers or mainland army soldiers are actually on the Hong Kong streets right now dressed in Hong Kong police uniforms. So, for instance, from about a week ago, there’s this video of a Hong Kong riot policemen, who’s obviously from Hong Kong cause he’s speaking colloquial Cantonese, but then he turns to other riot policemen near him and starts speaking to them in Mandarin, which wouldn’t happen if those other guys were from Hong Kong, and indeed, he addresses them as comrade. So, there’s suggestion, which I think is pretty solid, that China’s already deployed. And so this is a situation which is going to get extremely emotional and it’s going to last a long time.
Mike Gleason: Very interesting development. Good catch there. That’s going to be something to keep an eye on, and yeah, maybe we’re witnessing the last stand there. As you mentioned, this could be quite interesting.