Rabobank: It This Dynamic Doesn’t Change Markets Will Get Shot In The Head

By Michael Every of Rabobank

Monocle Vision on US-China tensions

“Houston, we have a problem” was a headline I would have run with in yesterday’s Global Daily if: (1) I hadn’t finished writing it before the news broke about the US kicking China out of its consulate in Texas for various alleged nefarious activities; and 2) Bloomberg hadn’t stolen half of it after it had. (However, Bloomberg ran with just “We have a problem”, which is one of the greatest comedy missed open goals since someone asked my mum back in the 1980s “Where are the Andes?” and she blurted out “The end of your armies!” to general confusion rather than the correct response –usable only once in a lifetime at best– which is “On the end of your wrist-ies”).

Yet the Chinese consulate issue itself is no laughing matter. Barely a day goes by without some new line in the sand being crossed between the US and China, and this is diplomatically almost unprecedented – but then so much else is too nowadays. It is additionally reported that the US is seeking a Chinese individual in the San Francisco consulate who the FBI believe is responsible for industrial espionage – and this is claimed not to be an isolated case. Indeed, President Trump is also reportedly threatening to close further Chinese diplomatic missions in the US ahead. Meanwhile, China is moving to close the US consulate in Chengdu in response, and Wuhan and Hong Kong are also possible targets; and it has also retaliated against the UK for what it sees as separate diplomatic provocations over Hong Kong by last night blocking transmission of the English Premier League. The US NBA will be sweating very heavily, no doubt.

Once again we see both the US and China getting dragged into an escalating tit-for-tat, and we see it spilling over into areas that one would simply not have imagined could happen: which is, of course, precisely what does happen when two economic giants start to disentangle themselves over clashing political-economy and geopolitical positions. It’s just not something that most market scribblers have ever seen. After all, one needs to be in ones late-40s to even properly recall the first Cold War.

US Secretary of State Pompeo is going to give a speech today to commemorate 50 years since ‘Nixon went to China’ and brought the country back in to the world economy from behind the Bamboo Curtain. Please let’s not forget that’s how it actually went. Yes, China had to decide to open up and take undertake bold and visionary reforms; but the US and the West had to also allow China in as well. People tend to forget that fact today. This was a house the US built post-WW2 on blood, sweat, and tears –as well as realpolitik– not a global architecture that emerged fully formed, effortlessly, everywhere, as reading only the ‘Bloombergs’ of this world one would presume is the case.

Pompeo is likely to take out the biggest sabre yet and perhaps not even rattle it: he might go so far as to lick the blade, so to speak. It is almost certainly going to be a verbal evisceration of the Chinese Communist Party, a confrontational rhetorical thread he has been exploring for some time now. The key question is if it will also be a further US escalation with concrete actions to match given the significance of the anniversary. Meanwhile, Bloomberg plaintively tries to report that, yes, China is still buying US soybeans. Which, as we know, seems to be the only metric that matters to both ‘Bloombergs’ and President Trump, most of the time.

If having lived longer and/or reading more widely is a good thing to have done at present if one wants to understand what is actually going on, it also helps to have travelled a bit outside of the generic ‘Monocle’ world of glamorous (and not-so glamorous) hotels that the global business and financial elite used to circuit so frequently until recently.

Believe it or not, there are still parts of the world with geographic proximity and real economic motivations for all kinds of trade exploiting their different factor advantages – and yet which see virtually no goods, or people, or money trickle over the border. Perhaps they won’t be the anomaly for much longer, however. (On which note, France has de facto joined the list of countries banning Huawei from national 5G projects, and even Deutsche Telekom has just struck a deal with Ericsson, it appears; a US ban on TkTok on all government devices is also a step closer.)

Of course, we live in a seamless globalised world where all anyone cares about is yield and risk on/risk off, a destabilising dynamic that Karl Marx described prophetically in his works that led to the first Cold War. As a result, even this US-China diplomatic escalation doesn’t matter – for now. Yes, CNY is at 7.0 again, but that’s hardly a slump; yes, 10-year Treasuries are below 0.60% again, but there was no risk of them rising anyway and there are pressing local reasons for that (like the Republicans proposing to slash extended unemployment benefits from USD2,400 a month to….USD400 a month. That will do wonders for the V-shaped recovery!); and meanwhile the currencies you don’t want to hold in any kind of serious crisis, like EUR and AUD, are still holding up well. Indeed, as I told Bloomberg would transpire when asked about Houston yesterday, five minutes later things will rally as usual.

However, as I also stated, despite this is still the latest escalation in a series that will end up in an inflection point that means a real crash for US-China relations, for Hong Kong, and for the Yuan (with its mighty 1.76% share of global SWIFT payments, as released today), among other things, if the dynamic doesn’t change; and yet markets will seemingly refuse to notice until they get shot in the head.

That was something that actually happened a lot during the Cold War too.