By Alexandra Stevenson

• Aug. 4, 201

BEIJING — China’s currency weakened past the psychologically important point of 7 to the American dollar for the first time in more than a decade, a move that reflects the growing severity of the trade war with the United States and that could indicate Beijing’s growing desire to find ways to retaliate against President Trump.

The renminbi traded in mainland China on Monday morning at roughly 7.02 to the dollar, compared with about 6.88 late on Friday. A higher number represents a weaker currency. The last time China’s currency was weaker than 7 to the dollar was in 2008, as the financial crisis mounted.

Monday’s move by itself will not change China’s trade relations with the United States. But the shift past 7 renminbi to the dollar could represent a new stage in the economic conflict between the two countries. American officials, including Mr. Trump, have long criticized Beijing for manipulating its currency to help its exporters. Should the currency continue to weaken, the Trump administration will most likely see that as a dramatic retaliation to the White House’s mounting tariffs.

“This can too easily be taken as a trade war devalue to take the pressure off,” said Fraser Howie, an author and former banker who writes about China’s financial system. “To that point, it is the quiet pushback from Beijing.”

The move shook investors worried that Monday’s currency move could presage a new front in the trade war. Stock markets in Tokyo and Hong Kong, a city where shares were also hit by work stoppages on Monday, tumbled more than 2 percent. Futures markets indicated Wall Street would probably open lower, too.

The People’s Bank of China, the country’s central bank, said on Monday that the renminbi’s move was in response to the “unilateralism and trade protectionism measures and the imposition of increased tariffs on China,” but emphasized that the Chinese currency remained stable.

“The People’s Bank of China has the experience, confidence and ability to keep the RMB exchange rate basically stable at a reasonable and balanced level,” it said in a statement.

A lot will depend on what happens next.

The Chinese government tightly controls the value of the renminbi. Its value fluctuates within a tight range anchored to a midpoint set daily by the People’s Bank of China. On Monday, the central bank set that midpoint at 6.9225 renminbi to the dollar.

Should the central bank continue to move the midpoint weaker, that would give room for the renminbi to weaken even more. While the renminbi at 7 to the dollar does not drastically alter the landscape compared with when it was at 6.9 to the dollar, the environment would change considerably if the renminbi weakened to 7.5 or 8 to the dollar.

“If the currency does stay below 7 for another day, that is a sign that Beijing has ‘weaponized’ the renminbi as a tool to improve exports during the trade war,” said Andrew Collier, managing director of Hong Kong-based Orient Capital Research.

A weaker currency in effect helps Chinese factories defray the cost of rising tariffs. Should the renminbi weaken further, the Trump administration could respond with higher tariff rates to keep pressure on Beijing to reach a trade deal.

But Beijing runs some risks if it continues to weaken the currency.

A weaker currency could prompt wealthy Chinese to shift their money out of the country, so nobody wants to hold investments in a currency that is losing value. It could dampen the spending power of Chinese consumers at a time when Beijing needs them to keep buying to bolster economic growth. It would put pressure on domestic and foreign companies in China that have debt denominated in American dollars. It would also affect Chinese companies like airlines that buy oil in dollars.

New York Times

(See my quote below)

July 15, 2019

A shopping mall in Beijing. Retail sales and spending on infrastructure offered bright spots in data that otherwise showed slumping growth.CreditLam Yik Fei for The New York Times

A shopping mall in Beijing. Retail sales and spending on infrastructure offered bright spots in data that otherwise showed slumping growth.CreditCreditLam Yik Fei for The New York Times

By Keith Bradsher

• July 14, 2019

BEIJING — China’s growth fell to its slowest pace in nearly three decades, officials said on Monday, as a resurgence of trade tensions with the United States and lingering financial problems take an increasing toll on one of the world’s most vital economic engines.

Chinese officials said the economy grew 6.2 percent between April and June compared with a year earlier. While such economic growth would be the envy of most of the world, it represented the slowest pace in China since the beginning of modern quarterly record-keeping in 1992. That marks a significant slowdown from earlier this year, when growth came in at 6.4 percent, matching a 27-year low reached during the global financial crisis a decade ago.

Premier Li Keqiang set a target in March for economic growth to be between 6 and 6.5 percent this year. The figures on Monday fell within that range.

But much of the growth in the quarter may have taken place in April and early May, when public confidence was higher because of a tax cut in March and heavy infrastructure spending as spring began. Trade talks broke down on May 10 and President Trump raised tariffs sharply on Chinese goods, a step that damaged consumer confidence within China. Growth early in the quarter also would have taken place before the contentious government takeover of a bank in late May hurt financial confidence.

Chinese officials on Monday acknowledged that conditions are becoming increasingly difficult.

“Economic conditions are still severe both at home and abroad, the global economic growth is slowing down, the external instabilities and uncertainties are increasing, the unbalanced and inadequate development at home is still acute, and the economy is under new downward pressure,” said Mao Shengyong, a spokesman for China’s National Bureau of Statistics, in a news conference.

Mr. Mao downplayed the effects of trade, saying China’s economy increasingly relies on consumption.

But President Trump, in a Twitter message on Monday about the economic data, said that tariffs on Chinese goods “are having a major effect on companies wanting to leave China for non-tariffed countries.”

“Thousands of companies are leaving,” he said. “This is why China wants to make a deal with the U.S.”

Monthly economic data, particularly for imports, suggests that the second quarter started strong but then slowed. “There was certainly a surge in activity through April,” said George Magnus, a longtime specialist in the Chinese economy who is now at Oxford University. “Something happened in May.”

A used car dealership in Beijing. Auto sales have slumped badly.

A used car dealership in Beijing. Auto sales have slumped badly.CreditLam Yik Fei for The New York Times

The number may also understate the extent of the slowdown. Economists widely doubt the veracity of the overall Chinese growth figure, which shows far more stability than comparable numbers from the United States and elsewhere.

A few sectors of the Chinese economy are doing fairly well. The strongest sector appears to be the construction of infrastructure, much of it paid for with money borrowed by local, provincial and national government agencies. Retail sales ticked up as well.

The biggest drag on the Chinese economy lies in trade, which grew powerfully over the past three decades but has stopped rising in recent months. Exports dipped 1.3 percent in June from a year earlier, the government said on Friday, and imports fell 7.3 percent.

While the trade war has hurt American purchases from China, economic weakness in Europe and many Asian countries has caused overseas demand to weaken far more broadly than just in the United States. Last week, Singapore unexpectedly announced that its trade-dependent economy had shrunk at an annualized rate of 3.4 percent in the second quarter.

“The economy is definitely in a broad decelerating trend because the global economy is slowing down, so exports are slowing down,” said Larry Hu, the chief China economist at Macquarie Capital, the investment banking unit of a big Australian multinational.

China’s troubles have their roots not just in trade but also in a debt-laden financial system that has been shaken by a series of large shocks in the last few weeks.

On May 24, Chinese financial regulators took over Baoshang Bank in Inner Mongolia, a small institution that is part of a financial empire previously controlled by Xiao Jianhua, a financier who disappeared into the custody of government investigators two years ago. Regulators tried to force a few of its largest creditors to accept losses rather than bailing them out as a way to teach financiers to be more careful about where they put their institutions’ money.

Problems in some of the shadowy corners of China’s financial system have also frightened investors. China’s shadow banking system plays an important role in funding property projects and other private business ventures. But managers of some riskier investment products have had a hard time making high-interest payments to investors in recent weeks. In some cases they have also had trouble even repaying principal.

These incidents have set off a broader shift in recent weeks away from riskier investments. Institutions and households alike have been putting money into larger, more stable financial institutions run by the central government.

Big state-controlled banks have steered the bulk of their lending to state-owned enterprises. That long-running trend has hurt the real estate market and the broader private sector. 

The Chinese economy has come to rely largely on government investment in infrastructure projects. 

Regulators have repeatedly urged the big banks to lend more to small businesses and the private sector, and Mr. Li, the premier, did so again on July 2. But these exhortations have had limited effect so far. Bank lending officers worry that they might be blamed, or even investigated for corruption, if they extend large loans to struggling private businesses that then default as the economy weakens.

Andrew Collier, the managing director and founder of Orient Capital Research, a Hong Kong investment and economic research firm, said that troubles at Baoshang and in the shadow banking system had rattled financial markets but seemed to have been contained, at least so far.

“The Chinese central bank is watching carefully, and for now will use quiet means to avoid any shaky financial shenanigans,” he said.

Economists are watching for other potential warning signs, like inflation. Price increases have been tame, according to official statistics. But many in China complain that the actual cost of living is rising fast, particularly for food but also for rent and other daily expenses.

Industrial production has weakened this year, as has private sector investment. Housing sales have slowed, as buyers look harder for bargains but sellers have been reluctant to cut prices. Car factories have sharply reduced output in response to weak sales, although there were signs last month that consumer interest in buying luxury automobiles may finally be stabilizing.

The long-running trade war has prompted many multinational companies to look at ways to shift supply chains elsewhere. But many continue to invest in China to supply China’s own market as well as others, especially in Asia.

“The Chinese government will continue to work hard to create a more stable, fair, transparent and predictable investment environment,” Gao Feng, spokesman for the Ministry of Commerce, said at a news briefing on Thursday.

He later added that “China has not experienced large-scale withdrawals of foreign capital.”

For now, though, the economy keeps running to a considerable extent because the Chinese government is pumping huge sums of money into infrastructure. It is building high-speed rail lines, immense highway bridges, ports and other facilities to connect ever smaller and less affluent cities and towns to the rest of the country.

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That infrastructure is making it easier to do business and move around even in some of the poorest and most remote areas of China. But bankers and economists worry about whether some of these investments will ever earn enough of a return to cover their cost.

“There’s a very weak commercial basis,” Mr. Magnus said, “for this credit-fueled infrastructure spending.”

Keith Bradsher has been covering the Chinese economy for The New York Times since 2002, as Hong Kong bureau chief and now as Shanghai bureau chief. He previously served as Detroit bureau chief and as a Washington correspondent covering trade and then monetary policy. Follow him on Twitter: @KeithBradsher.

The trade war – the Chinese response

Andrew Collier | Jun 07, 2019

Executive Summary

We analyze the response of China to the trade war in four buckets: politics, macro-economy, global supply chains, and technology. Of the four, China’s technological development and global supply chains are likely to suffer the most.

Xi’s political power is weakened

The political realm is the most interesting aspect of the impact of the trade war on China. Because Xi has established his central role in the country’s leadership, he thus will take full responsibility for the success or failure of the trade negotiations. His own policies have hindered his success.

Xi entered the trade negotiations with a weakened and more ineffectual bureaucracy due to the centralization of his power. To increase his direct control of the government, Xi created 29 new Leading Small Working Groups (LSG) on top of the existing 54. Xi personally controls at least a dozen. This has a) lessened the input of bureaucratic experts; and b) reduced the effectiveness of policy implementation. Among the casualties has been the trade war negotiations.

As a result, initial advice on the trade war came from just a few trusted advisors, who are far more powerful than the original top negotiator deputy, Commerce Minister Wang Shouwen. These include economics czar Liu He, briefly at Harvard, former PBOC head Zhou Xiaochuan. who studied at the University of California for two years, and CBIRC Chairman Guo Shuqing, who was at Oxford for a year. All three are part of what I call “globalists” who view the world in the rational terms of international trade. In turn, they reportedly relied on American advisors such as Hank Paulson and Henry Kissinger for advice on trade negotiations. The result was a disaster and a failure for Xi Jinping as neither the Chinese nor the American side had any insight into the Trump Administration.

Other foreign policy failures have further hurt Xi’s reputation. This includes the Belt and Road, which many domestic institutions view as a waste of capital, and the diplomatic opposition from many Southeast Asian nations to Xi’s clear attempt to broaden China’s economic and military reach. This has led to quiet grumbling internally among the elite, both at academic institutions, and among the Snancial and business crowd. These complaints include the following:

In October 2018, Peking University professor Zhang Weiying criticized the China Model for being both bad policy and bad facts: “(The China model) will mislead us and destroy our progress. If we single- mindedly emphasize the uniqueness of the China model, internally we will strengthen SOEs, enlarge the authority of the government, and rely on industrial policies, which will lead to a retrogression of reform

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and a total waste of the great strides in reform. The economy will lapse into a quagmire.” He was echoing other critics of Xi Jinping thought.
Xi’s assertive foreign policy is widely seen inside of China as a radical departure from Deng Xiaoping’s policy of keeping a low profile. More recently, public pledges of support for Xi within the State Council was viewed not as a sign of strength but of weakness – why ask for support if you are in a position of strength?

Deng Pufang, the eldest son of Deng Xiaoping, at a national conference of disabled persons, criticized the spirit of Xi’s policy and called for “seeking truth from facts … maintaining a clear head, knowing one’s own strengths and weaknesses, and avoiding overestimating oneself and behaving recklessly.” The speech was seen as an attack on Xi and quickly censored within China.
Long Yongtu, a former vice minister of commerce who negotiated China’s entry into the World Trade Organization (WTO) in the late 1990s, publicly criticized Beijing’s handling of the trade dispute with Washington.

What does this mean for the outcome of the talks? Short-term, not much. China’s closed media environment will prevent these incidents from reaching ordinary people and eroding Xi’s national power. However, longer term, Xi’s clear failure to manage the trade talks, along with his backSred attempts to create a more powerful global China, have damaged his inTuence within the elite in ways that are likely to come back to haunt him.

On the economic front, trade is just one factor

China is no longer as dependent on trade as it once was. Chinese exports to the U.S. account for only 3.6% of GDP, down from 7.3% of GDP in 2006. China has issued a rash of stimulus policies but it is not clear these are directed at the trade war as much as the slowing economy in general.

Pushing the economy

China has three mechanisms for controlling the economy: credit policy, Sscal policy, and the exchange rate. The state has focused its efforts on the Srst two by expanding credit and reducing taxes. There was a substantial increase in Srst quarter 2019 total social Snancing, whose effects we witnessed during our interviews in Fujian a week ago. Local investors said the property market said they had seen a sharp turnaround in the property sector, up from a 30% price decline in 2018. Credit growth has moderated since Q1 2019 but remains above GDP growth. On the Sscal front, the interest rate on corporate loans was cut by 1%, and Beijing has continue to encourage the issuance of local government bonds and corporate bonds for local government Snancing vehicles (LGFVs), as a way to put investment capital in the hands of local governments.

There was one policy clearly directed at the US tariffs. The Ministry of Finance announced two rounds of VAT rebates on a variety of products covering by the US$50 billion and $200 billion tariff lists. Along with other measures, the head of the Ministry of Finance, Kun Liu, said the total deductions would add up to Rmb1.3 trillion.

Despite these measures, Beijing appears to be digging in the for the long haul on handling the economic impact of the trade dispute on the domestic economy, and views it as part of a larger issue of keeping economic growth on an even keel.

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Propping up the yuan “behind the scenes”

Countercyclical factor

The one area that has not been touched is the value of the currency. Beijing is unwilling to broach the 7.0 level for the yuan. There are signiScant tools the state uses to maintain the stability of the currency. China has acknowledged this when in 2018 it introduced “counter-cyclical factor” to keep the yuan’s daily midpoint Sxed to a relatively stable value.

The PBOC said it would institute this retroactively to May, 2017. The PBOC’s China Foreign Exchange System (CFETS) requested banks to feature this factor in their daily Sxing to avoid “irrational Tuctuation” –- but not reveal their methodology. A more upfront policy was apparent when, in March 2019, China sold US$20.5 billion in US treasuries, the highest level since October 2016.

State support for the yuan

Yuan trading is dominated by the large, state-owned banks; foreign banks have low market share. SigniScant inTows have been managed by state entities to support the currency. According to SAFE, in 2018 the net foreign capital inTow grew 9% YoY to US$483.8bn, among which net FDI in the stock market rose 29% YoY. During the same period, the net purchase of domestic bonds by foreign institutions rose to US$96.6bn, up 68% YoY. Also, the net purchase of domestic listed stocks grew by 85% YoY to US$42.5bn. The strong momentum continued in 1Q19, with the net purchase of domestic bonds and stocks reaching US$9.5bn and US$14.9bn, respectively.

But much of this was probably not foreign capital. We estimate that 80% of this so-called “foreign capital” consists of domestic funds transferred to Hong Kong via back channels created by the Chinese government. This inward capital controlled by Chinese institutions is then required to be reinvested in the domestic markets under a new label: offshore capital.

These “back channel” routes for strengthening the currency support the dual role the state has played in promoting an image of the free markets while quietly propping up the yuan. Bottom line, we expect continued “hidden” support to keep the yuan above 7.0. “We have never taken any intentional measures that would cause depreciation of the yuan to offset [the impact] of conTicts over trade,” CBIRC head Guo Shuqing told state media in May.

Global supply chains are the wild card in the trade equation

The impact of the trade war on China’s integration in global markets is hard to predict at this stage given the uncertainty about the outcome of the discussions. China has a dominant capacity in a number of sectors, including telecommunications, which will be difScult for other countries to replicate in the short-term. Longer term, the cost advantages in Southeast Asia and India in particular, in addition to their lower political confrontation with the U.S., will make them attractive alternate sources of manufacturing capacity.

Already, there is signiScant movement of production to Southeast Asia. For the top two manufactured goods, China has greater than 35% market share and more than 20% for the rest, which makes it difScult for other

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nations to challenge in the short run. ASEAN trails China except in electrical machinery. Vietnam’s economy has been boosted by almost 8% due to a shift in production from China, resulting from the US-China trade war. The majority of Vietnam’s gains came from additional imports of goods covered by US tariffs on China, including electronic equipment for telephones, furniture, and automatic data process machines, because multinationals were able to move production to Vietnamese factories.

China’s tariffs mainly target commodities (soybean and oil) and, to a lesser extent, high-tech products that ASEAN economies hardly produce or for which they do not have any relative comparative advantage

The altered supply changes have been underway for some time, however. China’s inward FDI declined from 62% of total global FDI in 2006 to only 27% by 2017.

China’s hoped-for dominance in tech is at risk

Huawei is the bellwether for China’s foreign policy failures

It is in technology that China has mishandled the trade war particularly badly. President Xi Jinping’s aggressive posture on creating global giants, has backSred, as the U.S. has had signiScant support from Europe against China’s ambitions. This is not only a blow to China’s transition from low to high-value-added goods, but to the country’s personal prestige as a force in global tech.

Huawei is the poster child of China’s problems in the tech sector.

China’s global market share exceeds 40% in the telecommunication sector as well as in ofSce machinery. Ericsson and Nokia respectively hold 27% and 22% of the 2G/3G/4G gear market against 31% for Huawei. According RWR Advisory Group, Chinese state-owned banks have lent Huawei and Huawei’s customers up to £7.5 billion. More than 70% of Britain’s 4G infrastructure was built by Huawei.

Huawei, itself, has shot itself in the foot by misrepresenting its ownership. The company’s chairman claims it is owned by employees. But in a careful note, legal scholar Donald Clarke of George Washington Law School and economist Christopher Balding argue persuasively that the company is either privately held by the chairman himself or by the state through proxies. If it is owned by a trade union, this is essentially state ownership. However, the ownership structure remains opaque. “Regardless of who, in a practical sense, owns and controls Huawei, it is clear that the employees do not.” If Huawei is a proxy for the state then its claims to be operating without following national security goals are unlikely.

Global supply chain problems

Huawei is highly dependent on U.S. suppliers for semiconductors and software. Huawei reportedly stockpiled a year’s worth of semiconductor inventory, but it can’t stockpile software updates, which would be the Srst step in harming its operations. ZTE suffered a similar fate when the Commerce Department embargoed its operations, as it could not upgrade the Oracle database in its mobile base stations.

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Huawei supplies carriers in more than one hundred countries around the world. It is also going to be the lead in rolling out China’s 5G networks, which is poised to lead the world in new technology. The embargo could be a catastrophe to China’s attempt to become a leader in 5G globally.

Huawei would also lose access to the key design chips produced by western Srms like Cadence, Synopsys and Siemens’ Mentor Graphics. Reliance on US semiconductor Srms in future years will be questioned due to the political nature of the attack on Huawei. In turn, however, the American embargo could backSre and harm the U.S. semiconductor industry that supplies circuitry to Huawei.

Undermining Beijing’s ambitions: the Tsinghua example

Although Huawei says it is a private company, there is signiScant state support for the technology sector in general in China. Among other Srms, Tsinghua Holdings, under the state-owned Tsinghua University, is a signiScant Snancial backer for China’s tech sector. As China’s top university, Tsinghua University is far ahead of its peers in terms of investments. Acting as the University’s investment platform, Tsinghua Holdings Co Ltd (Tsinghua Holdings) mainly operates in Sve specialized areas: advanced technologies (integrated circuitry, environmental protection and healthcare); innovation services; sci-tech Snance; creative and cultural industries; and online education. These operations are carried out by three major afSliated comprehensive groups such as Tongfang Co Ltd., Tsinghua Unigroup, and Tus Holdings Co Ltd.

After spending approximately US$5.19bn, Tsinghua Unigroup established its presence in the chip industry and was able to convince the Chinese government to appoint it the lead backer for China’s Tedgling semiconductor industry. Since then, the company has become the prime instrument for China’s strategic development of the domestic semiconductor business and has received substantial support from policy banks and the government’s VC funds. This state-supported model is under threat due both to the trade war and the security concerns in other nations, particularly in Europe.

Conclusions: What are we likely to see out of the trade dispute?

1) Weak domestic opposition. The internal pressure on Xi Jinping due to his foreign policy failures is unlikely to cause a dramatic change in the country’s leadership. The domestic media is heavily controlled, and the dissent by inTuential academics and former leaders is not enough to alter domestic power relations. Xi’s failures, however, are being noted domestically, which could accelerate his departure in the future.

2) No easy bargaining chips. The two main demands by the U.S., the end of state subsidies and new rules governing IP protection, are either impossible or unlikely given domestic nationalism. China could offer a “clawback” agreement, suggested earlier by the Trump Administration, whereby examples of stolen IP or other transgressions would be met with a resumption of tariffs. This could be mediated by a third party – if the White House would agree. This, although it would be met with resistance, would be achievable within China.

3) Focus on the economy. The trade war is only a smaller part of the larger problem Xi is facing of a weakening economy and excess debt. Therefore, Beijing is unwilling to make signiScant concessions that a) would weaken the perception of the leadership domestically; and b) fail to solve the larger problem of the economy.

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4) Quiet concessions. Despite the conTicting aims, Xi is likely to use Liu He and moderates such as Steve Mnuchin as a “back-channel” to make concessions such as:

a. An increase in purchase of US goods.
b. An agreement to pay Snes if IP contracts are abridged.
c. Quiet curbs on companies such as Huawei.
d. Continue to offer opening to the domestic market, as Guo Shuqing offered in a speech in May.

All of these discussions would have to be deniable. The collapse of the talks recently followed an exchange of documents – it is doubtful the Chinese backtracked from verbal commitments as the Trump Administration has claimed. Instead, the agreement, once on paper, was less than the White House had wished for. The Chinese do not traditionally lie in negotiations but prefer to issue vague statements to give them policy freedom.

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Summary

China has instituted several targeted stimulus measures designed to improve GDP growth and provide capital for small businesses, the country’s largest employment sector. These measures, however, are likely to be inadequate compared with the decline in capital due to the restrictions imposed on shadow lending. The results are likely to be:

1. Difficulty maintaining land sales, which are already declining.
2. A potential downward trend in the property market.
3. Defaults of property developer bonds.
4. Continued rise in defaults of local SMEs.

The key point is Beijing is responding to tighter credit conditions by picking winners and losers. It is lowering credit to certain regions in order to restrict the allocation of capital. While official policy via the Peoples Bank of China (PBOC) can affect credit flows, the political system has a significant say in how the process works out. And we are seeing a distinct preference in those allocation decisions.

These measures are likely to provide less of a stimulus than the capital that was raised by the shadow banking system prior to the earlier crackdown. Newly increased RMB loans only amounted to RMB 1.8 trillion, not enough to compensate for the decline of RMB 6.5 trillion in shadow banking, which is more than three times larger. Although loan growth remained steady at 13%, total social financing has slowed to 9.8% from 14% a year ago. The chart below shows the decline in non-bank lending through mid 2018.This figure only includes “official” shadow lending, such as Trusts, and does not include other forms of non-bank lending such as wealth management products, which have seen flat growth even though the outstanding amount remains high at around RMB 30 trillion.