Yesterday, my colleague Harje wrote about the alleged hacking of US intelligence servers by China. You can read about it all here.
That story broke late last week. Around the same time that article emerged, US Vice President Mike Pence gave a speech that accused China of meddling in US affairs. From Bloomberg:
‘Vice President Mike Pence laid out allegations of Chinese election interference in a harshly worded speech Thursday, signaling a firmer U.S. pushback against Beijing as trade anxiety weighs on the looming midterm congressional elections.
‘Pence accused China of “a whole-of-government approach” to sway American public opinion, including spies, tariffs, coercive measures and a propaganda campaign. The speech at the Hudson Institute in Washington represented some of the most critical remarks about China by such a high-ranking U.S. official in recent memory.’
Yesterday, China’s stock market emerged from a week long holiday and promptly plummeted 3.7%. The ASX 200 had its worst day in over six months, falling 85 points, or 1.4%. The Aussie stock market is now trading at a near four-month low.
What’s going on?
Well, apart from our own abysmal political situation, which looks like we’re handing next year’s election to Bill Shorten, it’s all about China.
To be precise, it’s all about China and the US.
In short, the US is taking the fight to China and this is having major implications for the region’s stock markets. As Australia relies heavily on China/Asia, we’re not getting pulled into the downdraft.
I’ve mentioned this in previous Money Morning editions, but let’s do a quick recap…
The Trump administration believes previous US government’s sold the American worker and manufacturing industry out to China. China’s joining of the World Trade Organisation (WTO) in 2001 ramped up the process of globalisation. US manufacturing effectively shifted to China.
In effect, global multinationals used China’s lack of environmental and labour regulations to lower costs and increase profits. This allowed China to record unprecedented economic growth.
However, there are two sides to every coin.
China has also suffered from unprecedented environmental degradation. In trying to maintain its trade advantage, China has kept its currency weak by investing its savings back into the US. That in turn keeps US interest rates low and encourages more borrowing…the proceeds of which are then consumed on Chinese goods, and the process starts again.
China has been in the WTO for nearly 17 years now. Over that time, the whole global supply chain has been reengineered. The US produces very little high tech, national security type goods that are 100% made in the US.
Much of the high tech equipment is assembled in Asia. The article I linked to above explains how China inserted ‘spying chips’ into equipment made by a Taiwanese company called Supermicro.
‘The chips had been inserted during the manufacturing process, two officials say, by operatives from a unit of the People’s Liberation Army. In Supermicro, China’s spies appear to have found a perfect conduit for what U.S. officials now describe as the most significant supply chain attack known to have been carried out against American companies.’
This gives you some context for what Trump is doing. While the mainstream media portray Trump’s moves as ‘starting a trade war’, he is simply trying to level the playing field.
Such a move will come at a cost though. Long-term, it will be inflationary. Short-term, it will impact multinational profit margins, Chinese economic growth, and therefore, Australia.
ASX pricing in trade war possibility
The market looks like it is starting to price this future in. This morning, the ASX 200 broke below 6,100 points. With banks looking weak, it will be hard for the commodity majors to keep the index strong in the face of a Chinese economy under pressure.
The chart below shows the ASX 200 Materials Index. After declining during August and early September, the index enjoyed a sharp rally. But it now looks like turning down again. If it does, it will almost certainly drag the main index down with it.
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China, as always, has many tools to manage growth. It’s a centrally planned economy. But we’re not talking about a cyclical issue here. This is a secular trend that Trump is attempting to reverse.
The Hong Kong stock market (see chart below) gives you a good idea of what global capital thinks of the situation:
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After peaking in January this year, stocks in Asia’s biggest market have been in a relentless downtrend. The market is down nearly 22% from its peak.
Capital is fleeing China and Asia in general. That trend doesn’t bode well for Australia. The world sees us as a derivative of China. The risk is that global capital will start leaving our shores too.
Editor, Crisis & Opportunity
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