China: This is not 2019

Published on May 15, 2020
SGH Insight
Markets like to superimpose the framework of yesterday to handicap the uncertainties of tomorrow. When it comes to trading the reemergence of tensions between the Trump administration and Beijing, they should take note of two major shifts underway this year:

First, as opposed to the halcyon days of 2018 and 2019 when the pressure on China was largely focused on tariffs and technology, there are now well over a dozen measures in the pipeline between the executive branch and the U.S. Congress aimed at China.
Many of these were extensively laid out and handicapped in SGH 5/5/20, “China: U.S. Preparing Retaliatory Measures”, and two of them have already since come to pass, and roiled markets in the process — a forced “delay” engineered by the White House of the federal government pension Thrift Savings Plan equity allocation to China investments in the MSCI All World Index, and the roll-out by U.S. Senator Lindsey Graham of a “COVID-19 Accountability Act” against China.

Second, the market’s assumed correlation in 2018 and 2019 between a strong economy and tariff pressure on China, where President Trump, even in his own words, would use “house money” as it came available to pressure China, no longer exists; if anything, that relationship could now even be reversed.

The White House is, of course, single-mindedly focused on bringing the shattered U.S. economy back to its feet. But the recognition now even by the President himself that the economy may not have its “strong rebound” until the fourth quarter of this year at best is of enormous significance: the lower the odds of riding the economy through the November elections to win a second term, the higher the odds that Trump will press on his “America First” calling card that has been a consistent policy theme since becoming president.
Market Validation
(Politico 5/20/20)

In another sign of worsening relations, the Senate on Wednesday passed a bill that threatens to delist Chinese companies from American stock exchanges unless they submit to U.S. auditing requirements. Some of the biggest Chinese companies have refused to conform to those requirements with little consequence.

"It says to all the companies out there in the world, including, but not limited to China: You want to list on an American exchange, you have to submit an audit, and the SEC has the right to look at that audit, and audit the audit," said Sen. John Kennedy (R-La.) in a floor speech describing the legislation, which he co-sponsored with Sen. Chris Van Hollen (D-Md.).

Only the latest China cut: The bill was the second piece of bipartisan legislation targeting China the Senate passed in two weeks. Last Thursday, the upper chamber passed the Uyghur Human Rights Policy Act of 2020, which would sanction Chinese officials who played a role in the mass detention of Muslims and other minority groups in China’s Xinjiang province.

Markets like to superimpose the framework of yesterday to handicap the uncertainties of tomorrow. When it comes to trading the reemergence of tensions between the Trump administration and Beijing, they should take note of two major shifts underway this year:

First, as opposed to the halcyon days of 2018 and 2019 when the pressure on China was largely focused on tariffs and technology, there are now well over a dozen measures in the pipeline between the executive branch and the U.S. Congress aimed at China.

Many of these were extensively laid out and handicapped in SGH 5/5/20, “China: U.S. Preparing Retaliatory Measures”, and two of them have already since come to pass, and roiled markets in the process — a forced “delay” engineered by the White House of the federal government pension Thrift Savings Plan equity allocation to China investments in the MSCI All World Index, and the roll-out by U.S. Senator Lindsey Graham of a “COVID-19 Accountability Act” against China.

Second, the market’s assumed correlation in 2018 and 2019 between a strong economy and tariff pressure on China, where President Trump, even in his own words, would use “house money” as it came available to pressure China, no longer exists; if anything, that relationship could now even be reversed.

The White House is, of course, single-mindedly focused on bringing the shattered U.S. economy back to its feet. But the recognition now even by the President himself that the economy may not have its “strong rebound” until the fourth quarter of this year at best is of enormous significance: the lower the odds of riding the economy through the November elections to win a second term, the higher the odds that Trump will press on his “America First” calling card that has been a consistent policy theme since becoming president.

Below is a quick reference guide and analysis of ten “pressure points” in the pipeline against China, starting with “the big kahuna” of tariffs:

A Resumption of Tariff Hikes: While to date both sides have taken very deliberate steps to keep the Phase One Trade Accord on track, even if barely (see SGH 5/12/20, “China: Washington Picking its Battles”), we believe there is a non-negligible, perhaps 30% chance, that President Trump may still choose to hike tariffs on China.

After the phone call last Friday between U.S. Trade Representative Robert Lighthizer, Treasury Secretary Steven Mnuchin, and China’s Vice-Premier Liu He, both sides went to some lengths, as we expected, to reassure markets that the deal was still on. Sources at the highest levels in Beijing, however, have warned there is no way that China can meet its commitments this year, and Trump, from what we understand, has reserved judgment still on whether to hike tariffs again “over the next few weeks.”

Huawei Ban and Exemption: Today’s announcement by the Commerce Department that the U.S. would block shipments of semiconductors to Huawei Technologies from “global” chipmakers, implying an extraterritorial pressure on Taiwan and other non-US chipmakers, was accompanied by the announcement of yet another extension of the temporary license for mainly US rural carriers to continue using Huawei parts through August 13. But as opposed to previous extensions, this, it is threatened, will be the final one. Earlier this year, Congress approved a $1 billion “rip and replace” fund to assist rural carriers in finally weaning themselves off Huawei technology that should lessen the practical need for extensions, and the funding will most certainly need to be increased, and by a lot.

Senator Graham’s “COVID-19 Accountability Act” — Graham’s proposal, first flagged in SGH 5/5/20, “China: U.S. Preparing Retaliatory Measures” is cosponsored by four fellow Republican Senators, Thom Tillis (R-NC), Cindy Hyde-Smith (R-Miss), Mike Braun (R-Ind), and Rock Scott (R-Fla). The three main demands imposed on the People’s Republic in the bill in the proposed legislation — full compliance with COVID-19 investigations; closure of the wet markets, and; release of the arrested pro-democracy advocates in Hong Kong — benefits from strong political support across both parties, though the bill’s “authorization” to President Trump to impose sanctions on China should they fail to deliver on three fronts may prove less popular with Democrats.

Graham’s proposal follows a similarly hawkish proposal by Arkansas Senator Tom Cotton to authorize the sanctioning of foreign officials who distort or suppress information about public health crises. Regardless of whether these bills pass, we continue to believe the probability of sanctions on targeted Chinese individuals and/or institutions to be extremely high.

Equitable Act – Executive Order/PCAOB — Last fall, markets swooned on leaked reports that the National Economic Council was considering a bi-partisan measure, “Ensuring Quality Information and Transparency for Abroad-Based Listings on our Exchanges (EQUITABLE) Act,” introduced by Florida Senator Marco Rubio that would require companies to submit to U.S. audit and accounting oversight if they are to be listed on U.S. Exchanges. Most directly impactful, by a long shot, on Chinese listings, Rubio was joined in this bill by Democrats Bob Menendez (NJ) and Kirsten Gillibrand (NY), as well as fellow Republican Cotton (AK). While this proposal, given the initial market response, has lain dormant for some months since, the concept has not died, and as we warned, it was just picked up again by President Trump himself this week as a leverage point against China — if not a sound bill for market transparency.

Senator Hawley’s Lawsuit Immunity Act — On April 14, Republican Senator Josh Hawley (MO) introduced a “Justice for Victims of Coronavirus Act” intended to hold the Chinese Communist Party (CCP) accountable to U.S. victims of coronavirus by stripping the Chinese government of sovereign immunity from American lawsuits. Senate Majority Leader Mitch McConnell is said to be leery of bringing this measure to the floor for a vote, but its mere existence will fuel private and class-action lawsuits seeking to attach claims on Chinese assets, even if unenforceable (for now), as has already been brought forth by the Attorney General of Arkansas.

“Buy American,” Medical Supply Chain — In April of this year a bi-partisan, bi-cameral group of U.S. Senators, Rubio (R-FL), Elizabeth Warren (D-MA), Chris Murphy (D-CT), Kevin Cramer (R-ND), and Tim Kaine (D-VA), were joined on the House side by Representative Michael Waltz (R-FL) in introducing a “Strengthening America’s Supply Chain and National Security Act” to combat U.S. dependence on Chinese pharmaceuticals. The only question on this front is whether a measure to bring medical supply chains onshore comes through the legislative process, through a “Buy American” executive order from the White House, or both.

R+D, Relocation Expensing — On a broader level, National Economic Director Larry Kudlow earlier this year floated a suggestion that the tax code could be re-written to incentivize industries to move production facilities en masse to either domestic, or “friendly” (meaning non-Chinese) shores, through measures including a full subsidy for moving costs. While largely ignored by markets at the time, this shot across the bow was deemed serious enough by Beijing to rise to a discussion level in the Standing Committee of the Politburo (see SGH 4/16/20, “China: A U.S. Supply Chain Salvo”). While that idea is hugely expensive, the political pressure to relocate is and will remain intense, and reports such as the one just yesterday that Taiwan Semiconductor will be building an enormous state of the art facility in Arizona at a likely cost of over $10 billion will only encourage the administration to press deeper on this front. Indeed, just today, Kudlow suggested an alternative idea of cutting corporate taxes in half for companies that relocate to the U.S., albeit an idea we believe also with little likelihood of making its way into legislation.

Taiwan WHO Inhofe/Menendez – In what will be a certain irritant to Beijing, on Monday the Senate passed a bill (S.249) calling on Secretary of State Mike Pompeo to devise a plan for Taiwan to rejoin the World Health Organization. The bill was drafted by the co-chairs of the Senate Taiwan Caucus, Jim Inhofe (R-OK), and Bob Menendez (D-NJ), and passed the chamber unanimously. It pointedly notes that Taiwan had observer status in the World Health Assembly (WHA), the WHO’s governing body, until 2016, after which China, in response to the election of Tsai Ing-wen as President of Taiwan, sought to punish Taipei by excluding it from international organizations. While other countries may not go so far in challenging Beijing, the pressure to reinstate Taiwan to the board of the WHO has broad support in the international community, including across Europe, in Canada, Australia and New Zealand.

Uighurs Senate/House — Just yesterday, the Senate passed a bill, revised from a proposal first introduced last September, to impose sanctions on and revoke the visas of any Chinese officials accused of human rights abuses against Muslim minorities, specifically the Uighurs of Xinjiang. The bill (S.3744) was passed unanimously in the Senate and will need to clear the House of Representatives before going to the president’s desk for final signature. We believe it will.

Hong Kong Certification — Last week the U.S. State Department announced it would delay a report that is now required annually (H.R. 3289, passed on 10/15/2019) to certify whether Hong Kong still enjoys a sufficient degree of autonomy from Beijing to “justify continued special treatment by the U.S. for bilateral agreements and programs per the Act [the United States – Hong Kong Policy Act of 1992].” The reason cited for the delay was “to account for any additional actions that Beijing may be contemplating in the run-up” to the May 22 National People’s Congress “that would further undermine the people of Hong Kong’s autonomy [our emphasis added].”

We are not sure how State will rule, and this is a particularly sensitive one, but a negative certification would not only put Hong Kong’s special trading status with the U.S. at risk, but could also open the door to sanctions, including visa bans and asset freezes, on officials seen to be responsible for human rights violations in Hong Kong.

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