The mood music accompanying Joe Biden’s virtual summit with Xi Jinping was a loudly ticking clock.
Time is most certainly not on the side of US President Biden as inflation appears to rise as quickly as his poll numbers tank. Economic angst – and political gridlock – clouds his ability to put wins on the reform scoreboard ahead of Congressional elections a year from now.
The ticking Xi hears is that of a closing window to ensure today’s upswing in Chinese markets is backed up by fundamentals ahead of his long-planned coronation as the first three-term Chinese leader.
As Covid-19 risks flare up anew, domestic default risks abound and global recoveries disappoint, Xi is juggling more challenges than ever before.
For global investors, though, Monday’s chat was a momentous event. As expected, Biden and Xi emerged with only vague pledges of cooperation.
Biden told Xi that “our responsibility as leaders of China and the United States, is to ensure that our competition between our countries does not veer into conflict, whether intended or unintended – just simple and straightforward competition.”
Xi said that “the world is facing many challenges. As the world’s two largest economies, and as permanent members of the UN Security Council, China and the United States need to increase communication and cooperate.”
Yet it marks progress from the Donald Trump era when the US and China talked past each other on every issue.
Even if the leaders came away with few tangible deliverables, the healing can only begin with constructive, good-faith dialogue. Punters hope that Tuesday might have set the stage for the US rolling back Trump-era tariffs.
‘No winners or losers’
China-region markets surely liked what they saw from the meeting. The Hang Seng index rose 1.3% Tuesday, while the China Enterprises Index gained 1.5%. The Tracker Fund of Hong Kong is at a 10-day high as shares from Tencent Holdings to Alibaba Group to even the troubled China Evergrande Group enjoyed solid rallies.
Xi reportedly said the two biggest economies should “not engage in winners and losers.” Biden, meantime, told Xi “we need to establish some common-sense guardrails, to be clear and honest where we disagree, and work together where our interests intersect, especially on vital global issues like climate change.”
Until now, Biden has been reluctant to scrap Trump’s taxes on some US$500 billion of goods for fear of being called soft on China. That’s despite the US-China deficit increasing on Trump’s watch anyway. As inflation shakes American households, Biden may now have political cover to give free trade a chance.
“If Biden wants a win, he could ease on some of the Trump tariffs that are still impacting the US consumer,” says analyst Edward Moya at OANDA Corp.
One way to do it would be a tariffs-exchange rate quid pro quo. In exchange for Biden rolling back tariffs, Xi’s Communist Party could agree to halt the rise in China’s currency.
In recent years, the obsession in Washington has been accusations of an undervalued yuan. This, of course, was a particular Trump administration talking point. The worry now, though, is a frail dollar spooking world markets. Capping the yuan would essentially be China agreeing to ease monetary policy.
Given that the US now faces the bigger inflation problem, the People’s Bank of China has more latitude to increase liquidity levels. This would have to be managed carefully, of course. After all, China increasing the role of consumption would necessitate a stronger yuan. It’s a plus for global growth as Chinese purchasing power increases, boosting exports everywhere.
Inflation cum stagflation
Washington’s inflation troubles are much worse at the moment. Though China is seeing the fastest factory inflation in 26 years, the US is already recording the biggest consumer price increases in 31. That’s a clear and present danger to the inflation-is-transitory arguments coming from Federal Reserve chairman Jerome Powell and Treasury secretary Janet Yellen.
Should markets conclude differently – and hints are they have indeed – US yields could be headed sharply higher. The Fed, in turn, might be forced to play catch-up to regain control of markets. An actual Fed rate hike or two could provoke an even bigger cycle of traders bidding up yields, slamming stocks and economic growth.
One worry investors have about the US and China simultaneously is a situation where growth slows sharply and inflation accelerates. “China has entered a period of stagflation, with Beijing more inclined to validate stagnation than to fuel inflation,” says Diana Choyleva at Enodo Economics.
Choyleva adds that “we do not expect Beijing to embark on an interest rate-cutting cycle, especially as the Fed has started tapering, but it is likely to lower banks’ reserve requirement ratio to release liquidity and smooth the necessary deleveraging.”
This risks becoming a setback for China. A major Xi priority has been deleveraging, particularly in a property sector that generates about one-third of gross domestic product (GDP). Cutting reserve requirements now could set back progress in reducing runaway debt levels.
The world is watching more closely than usual as the default drama plays out at China Evergrande and other developers. And as Kaisa Group Holdings returns to the headlines. China’s third-largest dollar debt borrower among developers was also its first default ever on dollar debt back in 2016.
Complicating things, says analyst Wei He at Gavekal Research, is that “investors have been watching for signs that China’s financial regulators are relaxing their tough restrictions on financing to the property sector, which have pushed more and more developers into financial distress.”
As such, he adds, “the financial stress on developers has been amplified by a sharp slowdown in property sales, leaving them with few ways to raise cash. As a result, construction activity has slowed sharply, dragging down economic growth.”
The slowdown is terribly timed given Xi’s political plans for 2022, when he aims to extend his tenure for another three-year term. It’s clear that “there’s been a decision” in Xi’s inner circle “that this buildup of reckless credit expansion is becoming a danger to China and presumably a threat to the party rule,” says Leland Miller, the CEO of consultancy China Beige Book.
The good news for China is that household demand is holding up, despite worries about fresh waves of Covid-19 infections. Retail sales rose 4.9% in October from a year ago, beating forecasters’ expectations, just as Asia Times’ David P Goldman had predicted. Industrial production also increased – by 3.5% year-on-year in October.
Overall, though, “economic momentum remained weak in October” with the real estate “downturn weighing on industry and a new wave of Covid outbreaks dampening household consumption,” says Tommy Wu at Oxford Economics. Wu worries the property slump will drag down industrial production.
The specter of something worse befalling China worries Yellen and other top US officials.
“Real estate is an important sector of the Chinese economy,” she told CBS News. “And a slowdown in China, of course, would have global consequences. China’s economy is large, and if China’s economy were to slow down more than expected, it certainly could have consequences for many countries that are linked to China through trade.”
A Chinese inflation surge is something the global economy could do without. In October, its producer and consumer price indices rose 13.5% and 1.5% year-on-year, respectively.
Rising producer prices, says analyst Nicholas Chen at Fitch Ratings’ CreditSights, reflects an energy crunch that befell China amid rising coal prices.
“Winter is coming and the anticipated heating needs, especially in the colder northern regions of China, potentially place the demand-supply balance of coal in a delicate position,” Chen says. “The higher costs of production were likely passed to consumers, as seen in the uptick in the CPI last month.”
China, meantime, worries US officials aren’t taking inflation risks seriously enough. In October, US consumer prices surged 6.2% year-on-year, the fastest pace in three decades.
“The broad-based increase in prices ranging from food to used automobiles suggests that price pressures are encroaching into a wider range of sectors as higher costs of shipping and commodities permeate through the US economy,” Chen says.
The 49.6% and 59.1% year-on-year rise in gasoline and fuel oil prices last month, respectively, suggest inflation spikes are no fluke. At the same time, US employment is recovering, which will put upward pressure on wages.
“The improved labor statistics, coupled with the inflation pickup, may prompt the Fed to potentially raise interest rates earlier than expected and quicken its pace of tapering,” Chen notes.
China is sitting on nearly $1.1 trillion of US Treasury securities. The bigger problem, though, is policymakers letting rising price pressures get away from them. That could slam the dollar, sending global markets into a tailspin.
“I think the Fed is losing credibility,” says Mohamed El-Erian, chief economic adviser at Allianz. “I’ve argued that it is really important to re-establish a credible voice on inflation and this has massive institutional, political and social implications.”
Economist Stephen Roach, the former chairman of Morgan Stanley Asia, thinks the Fed needs to tighten immediately.
“They’re in denial,” Roach told CNBC on Monday. “They continue to harbor the view that these are transitory Covid-related rebound effects. I would just put the burden of responsibility on the Fed. The longer they defer a more meaningful monetary tightening, the greater the risks of stagflation.”
There was little in the Biden-Xi discussions to suggest a coordinated response to global inflation pressures or supply chain disruptions. Yet economists agree the mere fact that the so-called Group of Two is speaking again is reason for modest optimism for the year ahead.