'Global Splintering' Escalates Amid "Delusional" Markets

Authored by Michael Every via Rabobank,

For those who don’t read this Daily regularly, I have been warning that the US and China were heading for a real Cold War since late 2017, and I have been stating openly that the US was going to decouple from China for two years, with the sequence being trade, then tech, then capital. For a long time, this view was regarded as interesting or colourful, but extreme. Now it’s becoming mainstream - perhaps because it is impossible to ignore what is going on.

For example, US President Trump has signed an order banning TikTok in 45 days – and WeChat. As noted before, no WeChat, no chatting between the US and China given China bans Western apps. Back to the expensive telephone it is then…

…but not via a Chinese carrier. The US is also pushing ahead with a “Clean Network” policy that covers: ‘Clean Carrier’ to ensure no Chinese carriers are connected with US telecom networks; ‘Clean Store’ to remove untrusted applications from US mobile app stores; ‘Clean Apps’ to prevent untrusted Chinese smartphone manufacturers from pre-installing, or otherwise making available for download, trusted apps on their apps store; ‘Clean Cloud’ to protect US citizens’ most sensitive personal information and our businesses’ most valuable intellectual property; and, ‘Clean Cable’: to ensure the undersea cables connecting the US to the global internet are not subverted for intelligence gathering by China. This is as Google deletes 2,500 China-linked YouTube channels over “disinformation”.

In short, from both the US *and* the Chinese side, with their Great Firewall, we see a Splinternet developing. As the editor of the Global Times tweeted yesterday: “Pompeo’s call is to ultimately cut off China-US internet connection. This wild ambition will lead to fundamental consequences that humanity will be divided. With cooperation and exchange completely gone, China and the US will head for confrontation, followed by the risk of war.” So that’s tech.

On the trade side, next week is the crucial phase-one trade deal review. Trump’s presidential challenger Joe Biden has pointed out that China is falling very short of what it promised, upping the ante on the White House. Even before that, Trump signed another executive order to bring back US pharmaceutical manufacturing (from India and China, mostly), which apparently had been delayed by legal reviews. Of course, China’s trade data today showed exports surprising to the upside at 7.2% y/y vs. -0.6% consensus and yet imports -1.4% vs. a gain of 0.9% expected. That saw a monthly trade surplus of USD62bn(!) In short, China was a net drag on global growth as it bought less from everyone and sold far more – a mercantilism that will increase global protectionist pressures beyond pharma products.

The Global Times editor, bridging tech and trade --which WeChat does-- and brushing aside mercantilism, added: “Without merchants crossing the border, troops will appear. Clean Network will stifle China-US cooperation and divide the internet, which will inevitably intensify confrontation. There are already many points of friction between the two countries. Risk of hot war will rise.” So that’s trade.

We all know that after initial unhappiness, markets soon adjusted to US-China trade tensions - though bond yields continued to go lower. Markets are also shrugging off tech tensions, despite the fundamental global schism this implies, because most in Western markets don’t use WeChat. They are also naturally ignoring any thought of war – unless gold and bond yields are telling us something on that front.

However, markets may wake up when the US-China split gets to capital. The Wall Street Journal today reports “US Plan Threatens to Delist Chinese Firms”, noting that unless they comply with US auditing requirements, which none can, they would be forced to give up their listings by end-2022. Please don’t forget we also have the looming issue of sanctions over Hong Kong ticking away in the background, where legislation imposes an end-2022 date at the latest to restrict USD access to at least some Chinese financial institutions. The worst-case scenario of what this can mean has already been spelled out above.

Yet if one wants to look just at markets, look at Turkey. It has also emerged as a major global economy of geostrategic importance, and one not shy of going its own way domestically and in foreign policy. Yet it is on the cusp of a major currency crisis given it has run out of USD via a go for growth and go-for-broke strategy. This morning TRY was at a record low of 7.27 after state banks refrained from intervening on behalf of the CBRT, as they have been doing for months, and it’s hard to see where the selling stops. As our own Piotr Matys points out, major economic reforms are needed along with much higher interest rates, as they are 8.25% vs. 11.8% y/y inflation, and even then IMF help is likely needed (see here for more).

Yet the IMF still has the US as its largest shareholder and an EU member as its boss: are either going to be providing USD funds without changes to an expensive foreign policy that sees Turkey clashing with France, Greece, and Cyprus over energy, and with the US over Syria and missile defence? Great powers need power in all dimensions, as the Soviet Union found out when its economy failed, as China may also find out via its currency, and likewise the EU via its lack of a military.

On which front, the US needs to look after its economy. There was surprisingly good news yesterday on weekly initial jobless claims, which came in substantially lower than the 1.4 million expected, and all eyes will be on payrolls today. Yet there is still no sign of agreement in Congress on a new multi-trillion USD stimulus package, and we are instead reliant on rumours of further Trump executive orders on the likes of payroll tax cuts, unemployment extensions, and an eviction amnesty, without which consumer spending is about to face imminent collapse. As Matt Stoller tweeted yesterday: 

“Dear Republican China hawks: China’s main ideological claim is that their system delivers for their people, and ours doesn’t deliver for our people. The Republican strategy of throwing tens of millions into poverty during a pandemic proves the CCP’s point.”

Meanwhile, as Australia’s government joins the US in a Cold War, with defence spending set to leap 40% over the next decade, the RBA was keen to show in today’s quarterly Statement on Monetary Policy that negative rates are not going to be used, echoing the BOE a day earlier. The Bank is also expecting Aussie borders to be closed until at least the middle of next year – which is worth noting as everyone else keeps trying to reopen their skies only to then have to roll the measures back. Markets have been able to shrug off this global splintering so far too, but to imagine that countries can remain mostly closed to travel for 18 months and not see deep, lasting hysteresis effects is as delusional as thinking that the US-China dynamic does not really matter.