Special Trade War Update
The Quarterly Update series was created to demystify Economics and Investing. First published on March 30, 2017 and last updated on April 18, 2018.
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Special Trade War Update is a companion piece to my essay "The Case for Active Investing: Investing During the Trump Era," which I published in November 2016 after the Presidential Election.
Act I. Domestic Political Economy was published in March 2018
Special Trade War Update | Act I. U.S. Domestic Political Economy
Act 2. Retaliation
Act II. Retaliation was published in April 2018
Special Trade War Update | Act II. Retaliation
The United States, under President Trump, has demanded the following from China:
ㅡ Take Care of North Korea
ㅡ Stop Dumping Steel and Aluminum
ㅡ Reduce Trade Surplus by $100 Billion
ㅡ Stop Stealing Technology
"The Chinese have been shrewd practitioners of Realpolitik and students of a strategic doctrine distinctly different from the strategy diplomacy that found favor in the West." -- Henry Kissinger
Henry Kissinger wrote this seminal book on the History of China
Henry Kissinger was a Jewish refugee who fled Nazi Germany as a child. Kissinger practiced Realpolitik in his roles as National Security Adviser (1963 and 1973) and the Secretary of State (1973 to 1977). He is credited with all of the following foreign policy achievements: (1) Ushering detente with the Soviet Union (2) Opening dialogue with China and (3) Ending United States involvement in the Vietnam War. Friends at the J.P. Morgan Private Bank gifted this book to me for the 2012 Summer Reading List.
China Was the Original Superpower
And Was for Most of History
Cultural and Economic Superiority without American-style Universalism
However, China's Self-Imposed Cultural and Geographic Isolation In The Middle Kingdom Created A Disastrous Bubble
At its ultimate extent, the Chinese cultural sphere stretched over a continental area much larger than any European state, indeed about the size of continental Europe. Chinese language and culture, and the Emperor's political writ, expanded to every known terrain: from the steppelands and pine forests in the north shading Siberia, to the tropical jungles and terraced rice farms in the south; from the east coast with its canals, ports, and fishing villages, to the stark deserts of Central Asia and the ice-capped peaks of the Himalayan frontier. The extent and variety of this territory bolstered the sense that China was a world unto itself. It supported a conception of the Emperor as a figure of universal consequence, presiding over tian xia, or "All Under Heaven."
Tian Xia Disrupted
As late as 1820, Qing Dynasty China had the World’s #1 economy with GDP comprising 30% of the world’s total. But Economic Superiority alone was insufficient to preserve the Status Quo.
Unknownst Advances in Western Technology, such as Steam Power & Mass Manufacturing gave Invading Barbarians the Disruptive Military Firepower to Open China and Demand “Free Trade” to Pedal Opium for Silver
Opium War I: 1839 to 1842
"The Clash of Two World Orders"
Opium War II: 1856 to 1860
Left: "The Bridge of Kalikao," September 21, 1860. The French and English forces took this bridge, thereby conquering Beijing and winning the war. In the Upper Right: The Capture of Ye Mingchen after Canton. In the Lower Right, the signing of the Treaty of Tientsin, which ended the Opium Wars.
Chinese Realpolitik: Wei Qi and The Long Game
"In general, Chinese statesmanship exhibits a tendency to view the entire strategic landscape as part of a single whole: good and evil, near and far, strength and weakness, past and future all interrelated. In contrast to the Western approach of treating history as a process of modernity achieving a series of absolute victories over evil and backwardness, the traditional Chinese view of history emphasized a cyclical process of decay and rectification, in which nature and the world can be understood but not completely mastered."
Instead of chess or checkers, the Chinese play Wei Qi, a game of strategic encirclement
"Go" is a game about strategic encirclement, precision placement, and movement with long term objectives in mind. It is called "Wei Qi" in Chinese and "Badut" in Korean. Go is a complex game with very simple rules.
"Know Thy Place"
After Suffering Humiliating Defeat to Western Powers in the Opium Wars, China was Relegated to Second Tier Status
China has a long way to catch the United States which emerged as the Global Superpower in the middle of the 20th Century
Normalization
In the Realpolitik school of International Relations, each Nation is responsible for its own economic and military security in a "Realist" world of global state anarchy
Since World War II, the world has experienced an usually long period of peace, Pax Americana. Since the End of the Cold War, the world has experienced tremendous wealth creation under the United States, which emerged as the sole global Superpower. No country has been as Dominant as the United States in Military, Economic and Technological strength, since, well, China.
China has the world's largest population and access to significant sums of capital. However, China must catch up in advanced technology ㅡ if China is to reclaim Tian Xia
Meanwhile, China faces serious challenges, including the welfare of the aging population and rural political unrest. China's ability to address both vulnerabilities requires continued growth in China's economic engine.
China trails the United States in hard military power. China has a large standing military capable of territorial self-defense, but has no ability to project force outside of its boundaries. The Chinese will avoid any military confrontation during this Trade War.
Established in Confucian principles, and perfected over centuries, the Chinese system of meritocratic state bureaucracy staffed by the country’s elite creates ㅡ Institutional Memory ㅡ a critical success factor in Realpolitik
What Does China Want? ㅡ Normalization. Respect. Return to Global Leadership.
In his biography, President George W. Bush shared a side conversation that he once had with China's former President Hu Jintao (March 2003 -March 2013). Bush asked Hu what kept him up at night. Bush reported that Hu deadpanned, "creating 25 million jobs per year."
How Has China Done? ㅡ Foreign Exchange Reserves of USD $3 Trillion in 15 Years
The coffers are full.
China joined the World Trade Organization in 2001. China hosted the Summer Olympics in Beijing in 2008.
The Declining Barbarian
Populist backlash from America's Heartland elects Donald J. Trump
It's the type of political upheaval that the Chinese can understand
When facing the uncertain future, we turn to History. The Chinese are students of History.
Xi
Xi Jinping (born 15 June 1953) is a Chinese politician currently serving as General Secretary of the Communist Party of China, President of the People's Republic of China, and Chairman of the Central Military Commission. As Xi holds the top offices of the party, the state, and the military, he is sometimes referred to as China's "paramount leader"; in 2016, the party officially gave him the title of "core" leader. As General Secretary, Xi holds an ex-officio seat on the Politburo Standing Committee of the Communist Party of China, China's top decision-making body. (That's a mike drop. From Wikipedia).
Lifetime Appointment Can Play the Long Game
Xi will Appease & Curry Harmony with the U.S.
The Trade War creates a platform for Xi to bring China into a position of greater Global Prestige. China will earn respect for its forbearance. The World is watching, and President Trump is providing a heightened media platform for coverage.
"To give them . . . elaborate clothes and carriages in order to corrupt their eyes; to give them fine food in order to corrupt their mouth; to give them music and women in order to corrupt their ears; to provide them with lofty buildings, granaries and slaves in order to corrupt their stomach . . . and, as for those who come to surrender, the emperor (should) show them favor by honoring them with an imperial reception party in which the emperor should personally serve them wine and food so as to corrupt their mind. These are what may be called the five baits."
Trade Deficit
China should understand the optics of President's Trump's demands to reduce its Trade Surplus with the United States. Shown below, China's exports to the U.S. continue to surge.
China's Exports to the United States are shown in Blue, and increased by 10% in 2017. Note that Chinese Exports to the US increased at the same time that the Chinese Renminbi strengthened from 6.9 to 6.2 RMB per U.S. Dollar.
U.S. Energy Renaissance
The United States will Eclipse both Saudi Arabia and Russia as the World's Most Important Energy Producer. For example, the associated gas production from shale oil is abundant, solidifying the United States as lowest cost producer of LNG.
Most LNG around the world is sold using a price formula linked to Brent crude oil at a ratio of 6:1. For example, at $70 Brent, LNG is priced at $11.66 per one million British thermal units. However, as an alternative supply source, U.S. Export LNG can be purchased for less than $8 per unit. The U.S. Natural Gas price advantage only increases with higher oil price environments.
Fortune Cookie #1: China will purchase United States Liquefied Natural Gas
Buying U.S. Export LNG is an Easy Bait for China
North Korea
Fortune Cookie #2: China will defuse Rocket Man
On March 28th, one month before the first Inter-Korean Summit since 2007, and two months before the historic summit with the United States, North Korea's Kim Jong Eun, the Dear Leader, took an armored train to Beijing to meet with Xi Jinping
Kim Jong Eun's visit to Beijing reminded me of Henry Kissinger's story of Kim Il Sung's trek to China and the Soviet Union in 1950. Kim Il Sung wanted to force Korean Reunification by invading South Korea, but he first needed get approval from China and Russia. Per Kissinger's account, neither Mao nor Stalin explicitly forbade Kim from invading South Korea, and so, Kim Il Sung took advantage of the ambiguity and started the Korean War. As a result, North Korea put China in a hot war against United States, the last thing Mao wanted.
There was likely no ambiguity in the March 2018 Summit between China and North Korea. I think Xi said: Stand Down.
North Korea has violated international norms and treaties in its unrelenting pursuit of building nuclear weapons. Hwasong-15 and its breakthrough range puts the United States at existential risk, which is unacceptable to the current Trump administration.
Technology
Fortune Cookie #3: China will agree to normalize its technology practices
Understand Your Enemy
We translate Sun Tzu's The Art of War to read "Know Your Enemy." Interestingly, in Chinese, a better translation is "Understand Your Enemy."
"China’s long-term time horizon is legendary. It is not hard to find people in China who specify that time horizon at 31 months." written by Don Straszheim, China Analyst for Evercore ISI.
For reference, "31 months" is November 2020. In my opinion, China will do everything in its power to Appease President Trump, while buffeting their own international standing.
The Nuances of Knowing versus Understanding
Coming Next!
Act 3. The End Game
Archive | The Quarterly Update
The Trade War Special Update series was first published on March 2018 and last updated: April 17, 2018