Tech war rumors cloud sound Chinese fundamentals
Trump is likely to strike trade deal with China, despite apparent efforts by the intellegence community to sabotage a truce with attacks against Huawei
After a flat session, US equities jumped on a report from The Wall Street Journal that Treasury Secretary Steven Mnuchin proposed to roll back tariffs on Chinese imports “as a way to calm markets and give Beijing an incentive to make deeper concessions in a trade battle that has rattled global economies.”
The Dow Jones Industrial Average rose 250 points on the news, and retraced downward after a Treasury official dismissed the report.
Diverging Administration views have leaked into the newspaper over the past 24 hours, including a report yesterday that federal prosecutors planned a criminal investigation against Huawei for allegedly stealing trade secrets of “Tappy” – a smartphone testing robot – from T-mobile, and a rumor that Germany was looking for ways to keep Huawei out of its 5G rollout.
There is a fine line between reality-show theater and real disagreements inside the Administration. The trouble isn’t so much the opposition of “free traders” like Mnuchin and economic adviser Lawrence Kudlow against “hard liners” like US Trade Representative Robert Lighthizer and trade adviser Peter Navarro.
The Administration’s potshots at Huawei, including the arrest last month of its chief financial officer in Vancouver and the arrest last week of a Polish Huawei executive for alleged espionage, suggest a provenance in the US intelligence community. Some media commentary Thursday morning claimed that the Huawei business would reignite the trade war.
All of the press reports should be viewed as self-serving interventions by parts of the US government advancing divergent agendas. The Wall Street Journal claims that “Germany is exploring ways to ban the use of Huawei Technologies Co. products in the country’s telecommunications infrastructure” is suspect.
The US government asked Germany to keep Huawei out, and the German telecommunications security office politely responded that it had no proof of wrongdoing. At US insistence, the Germans will go through the motions of examining Huawei’s behavior, which in Journalese turns into “exploring ways” to kick Huawei out of Germany.
The report was crafted in such a way as to make confirmation or denial impossible. But the Bund Deutscher Industrie, the country’s main manufacturing association, declared that no company should be excluded from doing business without proof; it may be assumed that the association communicated what the German government thinks.
It’s hard to trade stocks when the financial press reads like a bad spy novel; that is the fault both of the spies, who should circulate disinformation more artfully, and the Wall Street Journal, which should know better than to publish dodgy leaks.
I continue to believe that Chinese market fundamentals are good (see my Jan. 10 column). President Trump clearly is inclined to strike a deal with China, as he demonstrated by intervening to settle the ZTE problem a year ago, and again in his Dec. 1 Buenos Aires summit with Chinese President Xi Jinping.
Ultimately what matters to the president is politics, and shrinking world trade and sagging stock markets won’t help his re-election campaign. Other elements in the government, especially in the national security establishment, want a confrontation over Huawei. The reins of government are slack in the president’s hands, but I expect his instincts to prevail.
Investors should stay focused on fundamentals. The China debt bomb story was always bogus, based on a basic misunderstanding of China’s financial system. China and the US have the same debt-to-GDP ratio (but China has twice the growth). American debt is concentrated in the federal government, whose debt is about 110% of GDP not counting unfunded liabilities. China’s government debt is tiny, but its corporate debt is big. That’s just an accounting convention, though: Chinese government banks lend to Chinese state-owned companies to build infrastructure. China has the same level of debt as the US relative to GDP, but it got something for the money.
The chart shows who owes China’s corporate debt. The 30 companies shown in the chart together account for 62% of the nonfinancial company debt of the Shenzhen300 stock index. The bars show the cumulative share. Shanghai Pudong Development, the main Shanghai port operator, has 18% of the total debt. Add China State Construction Engineering, and together they owe 21% of the total, and so forth. Of the 30 top debtors only two are not infrastructure companies (SAIC Motor and BOE Technology).
The revenues created by infrastructure don’t necessarily flow to the providers of infrastructure. That’s a matter of internal pricing. The profitability of the infrastructure companies may or may not reflect their economic contribution. That depends on transfer pricing among government entities—the state-owned banks who lend to the state-owned companies.
China used the SOE balance sheet to build some of the world’s best infrastructure, raising the ratio of net debt to EBITDA from about zero to over 6 times in 2014. It is gradually declining and forecast to fall back to a manageable 4X EBITDA by 2020.
