Who Watches the Watchmen?

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The US strategic course in dealing with the Soviet Union was called containment.  The US formed alliances with many countries that surrounded the Soviet Union and the East bloc.  Some think that the same broad containment strategy is now aimed at China. 

Trump’s strong rhetoric during the campaign and his first seven months as President, spurred ideas of a more direct confrontation with China.  Yet, on the contrary, Trump has not carried through with any of his threats and China is arguably in a better strategic position than it was a year ago.  

For various strategic reasons, Obama declared America’s pivot to Asia.  It was a long time coming and reflects what was happening on the ground.  For more than a quarter of a century, the movement of goods across the Pacific exceeded trade across the Atlantic.  The center of the world economy has shifted toward Asia.    Growth is faster, and populations larger and younger.  Asia is also contested territory.

In the old Trilateral language, there is the dollar-bloc and the euro-bloc, but  Asia does not have an anchor currency.  It is not a bloc.  China is the dominant economy in terms of size and in terms of trade, but its currency and capital markets do not dominate.   It is also a dangerous region.  North Korea, Pakistan, India, and China have achieved nuclear capability.  Iran may be biding its time, but its ambition seems clear, even if deferred.

 China has done remarkably well during the first several months of Trumps’ presidency.  Among his first decisions was to pull out of the Trans-Pacific Partnership trade deal that Obama had driven as a key pillar of the pivot to Asia.  China was not invited to join, and after the brouhaha over the Asian Investment Infrastructure, it seemed like a hardening of the parallel institution approach.  Some Chinese officials saw the TPP as part of the new US containment policy.  Trump withdrew from the negotiations, and it is hard not to see China as the chief beneficiary of that decision.  It is freer to pursue its free-trade agreement, which will likely be shallower than TPP.

Trump, like other recent presidential candidates, threatened to cite China as a currency manipulator.   He seemed so adamant that many thought it was likely, even inevitable.  Alas, China has not been cited. Nor will China likely be cited in the next report due in Q4.  The dollar’s broad depreciation this year, partly as a result of disappointment with progress on Trump’s economic agenda, has taken pressure off the Chinese yuan, which has also been defended by capital controls.  The yuan is up about 5.3% this year.

Many observers argued China had excess reserves a couple of years ago as it approached $4 trillion.  At the start of this year, they dipped below $3 trillion, and the chins were set wagging that it may not be enough.  Through July, China’s reserves have risen by nearly $90 bln in six consecutive monthly increases.  Valuation has been boosted by the appreciation of non-dollar currencies, but there has also been an increase separate from valuation.

To be sure Trump has announced several trade investigations, including most recently about China’s intellectual property violations.  But there has been very little following through.  The steel investigation, on national security grounds, was finished several months ago, and despite threats and posturing, there has been no concrete action.    There are bilateral talks with China, but after some token gestures, like the long overdue lifting of the ban on US beef, there has bee very little meaningful achieved yet.

President Trump toyed with the idea of breaking from US one-China policy.  However, here too Trump has come around and is no longer threatening to recognize Taiwan.  Trump’s arms sales to Taiwan may be one of the few US actions (leaving aside words) this year that went against China’s interest.

China has made a couple of concessions to the US on Korea.  It agreed to stop its coal imports from North Korea.  It also voted at the UN Security Council in favor of additional sanctions against its ally.   North Korea’s development of nuclear capability is not in China’s strategic interest.  The North Korean threat is spurring countries in the region, like Japan and South Korea (with the US help) to install missile defense systems, which also ostensibly can be used against China as well.  In fact, China is so perturbed that it has imposed sanctions on South Korea.

The US faults China for not doing more to rein in North Korea.  However, China’s rationale is likely not much different than the rationale in the US for not seeking an oil embargo against North Korea that were very punishing.  The likely human disaster would result, and for China, which shares a border, it could pose security issues and a potential refugee problem.

Lastly, the US apparent retreat from the liberal global order it was instrumental in creating, has left a leadership vacuum that also works in China’s interest. Ironically, President Xi can offer himself as a key defender of the liberal global order, and in so doing, casts Trump as the revisionist.    If Trump wanted to turn American foreign policy around and have a rapprochement with Russia and confront China, after seven months, the outcome is starkly different.  Congress, over Trump’s objections, passed new sanctions against Russia, North Korea, and Iran, and make it difficult (but impossible) for Trump to lift them.    The US has imposed new sanctions on individual Chinese people and firms who are thought to be assisting North Korea.  While this does not set well with Chinese officials, the direct harm is minor.

China’s strategy for dealing with Trump is intact.  Make some concessions that are highly visible.  Give Trump some small victories, which include doing what China would eventually do in any event, like lift  US beef ban (which addresses not only the weakening of Chinese agriculture but also the water shortage as beef but and especially grains are an incredibly efficient way to transport water) or buy more natural gas.  Avoid doing anything particularly provocative.  President Xi may also seek to out the last Trump insofar as Xi’s second five-year term begins shortly, and it is not out of the question for him to serve a third term too.

The yuan is at its best level since mid-2016.  At CNY6.61, the dollar has retraced 38.2% of its rally against the yuan since early 204 low near CNY6.04.  The 50% retracement is found near CNY6.50  Technical indicators are stretched.  Though there no signs of divergence of an imminent bottom, the greenback appears poised to stage a recovery.  Initial resistance is seen near CNY6.65-CNY6.68.