EU-NATO Last Week; This Week China

 

Do you even remember the beginning of the week? It began with the Trump-Putin Summit on Monday in Helsinki. The press conference between the two leaders created a massive fake media storm. How did President Trump handle it? First by demonstrating how tough he is & has been on Russia and then in two days inviting President Putin to visit the White House this fall.

1.Look East, Folks

Besides a very sturdy backbone, President Trump also demonstrated what he is trying to do – Move from a small, soon-to-be-ended cold war with Russia to a new momentous “dispute” with China. He sent Larry Kudlow, White House Economics Advisor, to CNBC’s Delivering Alpha Conference to deliver a clear message.

  • We have had Republican & Democratic Presidents in the past make these complaints to China;even take these complaints to the World Trade Organization ; they never followed through; they say it, nothing happens, life goes on; situation gets worse; you follow?
  • President Trump has the biggest backbone, this is one of the things I admire about him; he will not let go of this point; he will not; nor should he in my opinion;and China is going to have to come around; I am an optimist, this is solvable
  • “I believe China wants to make a deal; but, in so far as we know, President Xi at the moment does not wish to make a deal; Now I would love to be wrong on that; President Trump has a good relationship with him as he has spoken; we have worked together on numerous ways with respect to North Korea; hope springs eternal; communications continue; but I think Xi is holding the game up; I think … the others would like to move now; … I think he needs to move; we are waiting for him; the ball is in his court; and the tit for tat business, which is nobody’s favorite path, but nonetheless, they can end that this afternoon by providing more satisfactory approach and essentially Jimmy, doing what the rest of the world knows needs to be done; put tariffs down, put non-tariffs barriers down; IP theft No; allow American, British, German whatever full ownership of the companies operating in China;
  • let me make one last point here; President Trump inherited this mess and a broken trading system; If you talk to him as I have, so many times in the last 3-4 months, he sees himself as a free trader; people don’t get this; don’t blame Trump; blame China please; blame Europe that is going down the wrong road; he sees himself as a free trader; he has said in the Group of Seven and since, let us have no tariffs, let us have no tariff barriers; let us have no subsidies; let us have a tariff-free trade system; that’s his view; but you have got to protect the country ;

Why is President Xi being so resistant? Steve Bannon said at the same CNBC Conference – “… the warlordism in China right now,  is the State-owned industries;  Xi, right now, is under tremendous pressure … “.  The incessant demand for funds from State-owned industries is a big part of the Chinese Debt Bubble. But it is only one of the pressure points on President Xi Jinping.

2. Weakness of President Xi

A more detailed theory was put forth on June 27 by George Friedman, the founder of Geopolitical Futures in his article China’s Weak Dictator. Dr. Friedman begins with:

  • “Most observers take Xi Jinping’s ascension from president to dictator as a sign of China’s national strength. But I see things differently – Historically, as China rises, it loses stability. When it loses stability, it installs a dictator. The dictator may take the form of an emperor or party chairman, but he is a dictator nonetheless. It is in this context that I have begun to form a tentative theory: that Xi Jinping’s strength is a facade.

What is beneath the facade?

  • “Beneath the facade, China’s reality is far grimmer. Much of the population still lives in poverty. A significant component of the Chinese economic elite stand to suffer from Xi’s reforms. And China’s professors, diplomats and local government officials, especially on the coast, are nervous about the direction in which Xi is steering the country. Combined, these three groups could threaten Communist Party rule. To stop the threat from materializing, Xi must prevent a coalition from forming against him. This means a constant shifting of economic policy and political purges that aim to rectify China’s structural economic problems without creating revolutionary discontent. “

Into this stepped President Trump with his demands for a fair trading system with China. Dr. Friedman points out:

  • Trade tariffs are a tremendous threat to China. In just 10 years, China’s export-to-gross domestic product ratio has gone from about 32 percent of the economy to 20 percent. This is less a reflection of China’s very urgent strategy of de-emphasizing exports and more a function of lower demand abroad. The decline, brought on by the 2008 financial crisis, destabilized a vast part of the Chinese economy. Protectionist measures by the top destination for Chinese exports – the U.S. – threaten to further destabilize the system.”

Kudlow said “... others would like to move now …“. Who are these others & what would they prefer to do? Dr. Friedman writes:

  • “These factions [moderate liberals and internationalists] see Chinese integration into the international economic system as a necessary component of modernization and prosperity. And no component of the Chinese political system is more attached to this internationalist posture than China’s diplomats …”
  • The instinct of the diplomats … is to bridge the gap with the United States. From a purely economic standpoint, they are right. … The proper diplomatic approach to this new challenge would be a policy of accommodation, one that assuaged the U.S. and allowed trade to continue unencumbered.

But wait. Remember what has been the core belief of the Chinese leadership, the core belief that has been instilled in China and that has spread to many regions in the world – belief that America is a declining power and time is on China’s side in achieving its historical standing as the world’s superpower. 

Add to this the mesmerizing Made in China 2025, the drive to leapfrog America and become the world’s dominant leader in advanced chip design, robotics, artificial intelligence and advanced manufacturing.

It would take an extraordinarily strong and exceedingly popular leader to step down from this high horse and engage in visible accommodation with President Trump.

But that is hard for dictators, especially for a newly anointed Dictator for Life. As Dr. Friedman writes,

  • ” … politically they [diplomats] cannot grasp the dilemma the emperor faces Xi cannot be seen as weak. He must retaliate, even if his ability to inflict damage on the United States is limited. This is all part of the facade – to get Chinese citizens who will be hurt by Xi’s moves to feel a sense of embattlement and loyalty to Xi’s regime.”

3. Strength & Resolve of President Trump

President Trump is absolutely clear and has made it clear that if China retaliates, then he will add more tariffs & other far stricter measures. President Trump is not going to back off and the Chinese feel clueless, as Steve Bannon said at the CNBC Conference:

  • ” … for the first time in the last 25 years, they don’t know what to do; they are seeing an opponent standing up for themselves … ”

And they have never seen an opponent like President Trump. He is unlike any other leader, diplomat they have faced in the last 25 years.

Remember what President Trump wants per Kudlow – “… put tariffs down, put non-tariffs barriers down; IP theft No; allow American, British, German whatever full ownership of the companies operating in China … “. This is not a laundry list though it sounds like one. Dr. Kudlow was being soft & diplomatic. Mr. Bannon did not need to be that. So how did he express this?

  • I think the No 1 thing you are going to see out of the Trump Administration is the re-orientation of the complete supply chain of Japan, Western Europe and the United States & South East Asia, that 800 million people even before you get to India, around the freedom-loving countries … what you are going to see is re-orientation of the entire supply chain out of China.”

Then he added in the typical Bannon style:

  • ” I think the regime in China is in deep trouble … right now we are converging on a point and they understand this; we can take the whole thing down; it is built on a house of sand“.

 

 

4. Next Steps

Regardless of the deep troubles of Xi & China, we don’t expect them to accede to President Trump’s demands without fighting back. One way to fight 10% tariffs is to lower your currency by 10%. Lo & behold! This week the Chinese yuan dropped to its lowest level in two years vs. the U.S. Dollar:

  • Chart: This is starting to look like an intentional devaluation by Beijing to offset the impact of US tariffs; onshore & offshore yuan

President Trump sent a shot across the Chinese bow on Thursday by remarking “China’s currency is dropping like a rock” in his interview with CNBC’s Joe Kernen. This verbal intervention immediately stopped the Dollar from going to a new high & it fell over 1.5% by Friday.

More importantly, President Trump’s comment is seen as a potential warning of China being declared a Currency Manipulator in U.S. Treasury’s report due on October 15, 2018. Indeed, Treasury Secretary Mnuchin followed President Trump’s comments by telling Reuters on Friday:

  • “The United States is monitoring the recent weakness in China’s yuan currency and will review whether the currency has been manipulated”

Those who dismiss the scale of this confrontation between President Trump & China should read about the similar confrontation between President FDR & Imperial Japan in late 1930s. President Xi, the new dictator for life, seems to have been over-aggressive and over-arrogant in every sphere – against other factions in China, against America with his Made in China 2025 and against every state in Eurasia with his One Belt One Road signature platform to engulf smaller countries first into debt and then into servitude to China.

These conditions are tailor made for trouble for President Xi or at least for rumors about coalitions forming against him. The fact that such rumors might be circulating itself gives some credence to Bannon’s statement about the cult of personality around Xi regime being in a degree of trouble. 

The question is, given all the troubles President Xi is facing, does he need a visible confrontation with President Trump to stay in power? Hopefully not.

 

 

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