US-China Growing Friction: The Thucydides’ Trap in Motion; Flight to Safety? Record Global Negative Bond Yields and Surging Gold Prices
US-China Friction: The Thucydides’ Trap in Motion
Figure 1
The first tweet is from the New York Times reporting the withdrawal of the US administration from the Intermediate-Range Nuclear Forces Treaty (INF). The offshore yuan’s near low record close last Friday as reported by the South China Morning Post’s tweet. Displayed in the lowest window is Bloomberg’s 5-year chart of the offshore yuan, the CNH.
These unfolding events are interrelated and don’t exist in isolation.
These are part of the pieces of a puzzle falling into place.
The other pieces:
-Hong Kong’s massive popular protest against the Chinese government, which the Xi government blames on US government meddling. The Chinese military, the People’s Liberation Army PLA, has been threatening to intervene in Hong Kong’s riots. If they do, what happens to the one country two systems?
-The Chinese government suspended individual tourists from entering Taiwan, which the latter’s government protested. Such actions appear to be in response to the Taiwanese President’s recent visit to the US, the proposed US government’s $2.2 billion worth of arms sales in early July and a US warship sailed through the Taiwan Straits a week ago that stirred friction. Taiwan alsoreported test-firing missiles as military exercises were held by the Chinese government nearby. Likewise reported last week was a collision between a Chinese warship and a Taiwanese freighter near a Taiwan controlled island.
-North Korea, a staunch ally of the Xi government, was reported to have carried out its 3rd missile test in just over a week.
-The buildup of China’s military forces at South China Seas appears to be intensifying with a reported secret deal for Cambodia to host a Chinese military base. Last week, the Philippine defense minister accused the Chinese Government of “bullying” over claims in the South China Sea.
-Following the US Trump’s “let us down” diatribe on Fed Chair Jerome Powell’s 25 bps cut, the Trump administration decided toslap 10% tariffs $300 billion in Chinese imports.
-China’s biggest bank, the Industrial and Commercial Bank of China, has reportedly rescued Bank of Jinzhou with a Rmb3bn ($436m) representing a 10.82% stake. Notes the Financial Times, “Investors have grown concerned over the health of the Chinese banking system in recent weeks following the government takeover of Baoshang Bank, the first such incident in nearly two decades.”
-and other factors (repression of the Chinese minorities, e.g. Uyghurs, Tibetans etc.)
“The administration is hellbent on cornering the wounded animal. China’s historic financial and economic Bubbles are in trouble. Beijing has been working intensively to stabilize its money market and corporate lending markets. More generally, China’s overheated Credit system has become deranged. Financial conditions have recently tightened dramatically for small banks and financial institutions, while real estate finance remains in a runaway speculative Bubble blow-off. System Credit is on track to approach a record $4.0 TN this year, as Credit quality rapidly deteriorates…”
“President Trump sees the opportunity to use China’s weakened economy to extract trade concessions. As it drifts closer to a systemic crisis of confidence, Chinese finance is the more pressing issue. Remember how such circumstances tend to unfold: very slowly then suddenly quite quickly.”
The offshore yuan’s near-record low has signified a symptom of the escalating cracks in China’s economy, which was punctuated by this week’s second bank bailout by the largest state-owned.
With increased vulnerability, China’s slowing economy has been percolating to the political front, domestically and internationally.
And US President Donald Trump, with eyes on the 2020 re-election, could be pressuring its central bank, the US Federal Reserve, to ease to support the stock market, whose record highs he has owned, and the statistical GDP. Mr. Trump may have also used its bilateral trade relations with China as a fulcrum to influence the FED’s policies. Yes, the Executive branch now determines US monetary policy, as well as, the world.
And trade wars aren’t just about trade per se, but about including demand for changes in the domestic political institutions and geopolitical sphere of influence, which the Chinese government has been pushing back.
Put differently, decaying relational frictions between US and China haven’t been limited to trade but have been expanding to cover geopolitics, which reeks of the Graham Allison’s Thucydides’ trap defined as “the rivalry between an established power and a rising one often ends in war”.
And as China’s highly fragile economy reels from its massive scale of malinvestments built from an overdose of debt and which if pressured more by the US through trade tariffs and other barriers and by political pressures (Taiwan, Hong Kong, South China Sea, INF…et.al.); justifying these as provocations, the Xi Government may respond with military actions!
Through the escalation of geopolitical impasse, the dynamics of the Thucydides’s trap has been in motion.
There have been an estimated more than 130k Chinese workers (Pogo, construction, etc…) some living in reported exclusive enclaves, plus about 1.4 million Chinese tourists in the Philippines. Though the Philippine government denies this, how many of them work as undercover agents of the PLA? Should a conflict between the US and China breakout, will these PLA cells not be used to sabotage military targets of their adversary here?
Panic Buying Bonds, Record Negative Yielding Bonds, US Dollar Illiquidity and Surging Gold Prices!
Figure 2
Panic buying of global treasuries intensified last week.
Negative yields spread to Germany’s 30-year bund, a first-ever. Yields of 10-year US Treasuries plummeted to 2016 levels. Yields of Canada’s 30-year bonds relative to its overnight rates turned negative the first since 2008!
Figure 3
Supply of negative sub-zero bonds hit broke through $14 trillion last week. On Friday, a whopping USD 621.2 billion, thesecond-biggest single-day jump, pushed global negative-yielding bonds to a record $14.52 trillion! Also, a record 43% of global bond markets outside the US trade at negative territory!
Subzero rates don’t imply profuse liquidity conditions.
Cross currency markets have signaled higher borrowing cost on the USD, reaching their highest level this year!
Instead of borrowers paying interest to lenders, negative-yielding bonds mean the opposite, lenders paying borrowers to borrow: a negative return of investment for fixed income instruments! Capital consumption!
Have the panic buying of negative-yielding fixed income instruments been about momentum? Or have it been about frontrunning of global central banks in anticipation of massive money printing operations? Aside from the FED, central banks of Azerbaijan, Bahrain, Hong Kong, Russia, Turkey, and Saudi Arabia cut interest rates last week.
Or have the frantic bids on treasury markets have been about collateral, paying governments to safe keep assets?
Figure 4
It’s easy to see why.
The global economy increasingly has borne the onus of the US dollar illiquidity. The global manufacturing index has transitioned to a contractionary phase, raising the risk of a global recession.
In the meantime, foreign governments and central banks have been piling on into expanding the US dollar payment buffers,through the swiftly growing repo pool, contributing to higher costs of currency swaps.
And increasing strains in the global economy, financial conditions, and the geopolitical sphere have been prompting global central banks to stockpile on gold reserves, a 3-year high. Gold prices reach multi-year highs this week.
Have all these have been pointing to a bullish stock market? Or to the heightening risks of a violent adjustment process?
Can global central banks, now powered by President Trump, stave off the fast decaying global financial and economic, as well as, geopolitical conditions from aggravation?
