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“If we’re close to a deal where we think we can make a real deal and it’s going to get done, I could see myself letting that slide for a little while. But generally speaking I’m not inclined.”
That was Donald Trump talking about his 1 March deadline for raising US import tariffs on Chinese goods, if the two countries can’t agree a deal before then.
It’s quite a cagey comment, but markets chose to take it as good news. The US and China have been in a fresh round of talks this week. The tricky thing about agreeing a trade deal is that the US is looking for something more than a cosmetic agreement – it wants full-on reform, particularly with regard to China’s approach to technology development.
Is the US likely to get it? There was an interesting piece by hedge fund manager and long-term China bear Kyle Bass (with Daniel Babich) on Bloomberg, which argues that Trump should go to the wire if necessary.
“Chinese policy makers are desperate for a trade truce” to avoid any more pressure on their economy, Bass said. His argument is that China’s massive debt leaves it extremely vulnerable.
Now, that’s an argument that Bass has been making for many years now. But to be fair to him, it does appear that the Chinese economy is finally feeling the squeeze.
According to another news story on Bloomberg, two big Chinese borrowers have missed payment deadlines this month.
Private investment group China Minsheng “hasn’t returned money to bondholders that it had pledged to repay on February 1st”. Meanwhile, coal miner Wintime Energy, which already defaulted last year, “didn’t honour part of a restructured debt repayment plan last week”.
Why does this matter?
It’s good to get rid of Ponzi financing – but what do you replace it with?
There are two significant points here. One, there’s the fact that companies are defaulting at all. This has only really just started to be “allowed” in China, as part of its attempts to reduce the economy’s reliance on what is effectively, Ponzi finance (projects that can only ever survive with ongoing injections of money from elsewhere).
Of course, this has been going on for a little while now. The value of missed bond payments quadrupled last year from the levels seen in 2016 and 2017, having been virtually non-existent in 2015.
But that’s where we come to the second point: these are two particularly big examples. As Bloomberg notes, “if China Minsheng ends up defaulting, it may rank alongside Wintime Energy as one of China’s biggest failures.” The company has nearly $35bn-worth of debt.
Trying to unpick a system like this in a controlled way is virtually impossible, even in a heavily state-controlled system. The risk is that you pull out one untidy thread and a big chunk unravels – or you tug one block out from the Jenga pile and the tower goes over.
China is now trying to ease monetary policy again, which suggests a certain level of concern. But loosening monetary policy alone will not fix this. One problem is that the financial system is a mess, so no one is sure which companies are going to benefit from increased government largesse and which will not.
I’m not a fan of government bailouts, but if you’re going to do them, you need to at least be consistent for them to have their desired effect. If lenders don’t know whether the government is going to underwrite a company or not, then they’ll assume the worst and force the issue, one way or the other. So your problem doesn’t really go away.
On top of that inconsistency, notes Bloomberg, “the prevalence of shadow financing can make it hard to tell who’s on the hook for losses.” Shadow financing takes many forms, but the problem at its heart is that it often involves financial products that look like one thing (a bank-backed savings account, say) but in fact are another (a dodgy lump of corporate debt parcelled up to look like something else).
To get rich is frowned upon
A deeper, more important issue (to my mind at least) is that this is all happening in the context of a government that is moving away from liberalisation. China no longer thinks that “to get rich is glorious”, as Diana Choyleva of Enodo Economics points out.
This is not good for consumer confidence, which in turn is not great for a country that is ostensibly hoping to shift its economic focus from manufacturing and rampant infrastructure investment to consumer spending.
All in all, the trade war is just the cherry on top of this none-too-appetising cake.
That said, what does any of it mean for investors? Right now, given that America’s central bank, the Federal Reserve, has capitulated, markets just want an excuse to rally. Getting their hopes up about trade could well provide that excuse.
On balance, my base case view is that any sort of deal will get investors geared up to keep buying. And if the US economy shrugs off fears of recession then that’ll continue – as long as the Fed stays away from raising interest rates.