Daily Comment (February 28, 2024)

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today opens with new restrictions on information flows within and between the US and China, which will likely further decouple the two economies and exacerbate tensions.  We next review a range of other international and US developments with the potential to affect the financial markets today, including signs of potential new British curbs on Chinese electric vehicle imports and a range of US political and policy news.

China:  The government yesterday passed amendments to its State Secrets Law that will expand the types of information that must be protected.  Importantly, the amendments establish a new category of “work secrets” at government and party bodies that aren’t considered state secrets but could “cause certain adverse effects if leaked,” adding a potentially broad new category of restricted information.  Other provisions will restrict travel and work by people who leave sensitive positions and impose new rules on private businesses exposed to state secrets.

  • Implementing rules on the work secrets category are to come at a later date. The overall package of amendments is due to take effect on May 1.
  • The toughened law is only the latest example of how General Secretary Xi is actively prioritizing national security over economic growth or Chinese “soft power.”
  • The toughened provisions will likely add to the concerns of Western firms trying to do business in China, since they will put those companies and their employees at greater risk of running afoul of the law. In turn, that may further discourage Western investment in China, adding to the country’s economic headwinds.

United States-China:  In another development relating to information flows, President Biden will sign an executive order today limiting the sensitive personal data on US citizens that data brokers can sell to China and other adversarial countries.  The restrictions will apply to data such as genomic, biometric, personal health, geolocation, financial, and certain types of personal identifiers.  In large sets, those types of data could be used by adversaries for intelligence gathering and to facilitate illicit influence campaigns or computer hacking.

United Kingdom-China:  Reporting by Politico indicates the British government is considering launching an investigation into whether the Chinese government has subsidized its burgeoning electric vehicle exports in violation of global trade rules.  The probe would follow a similar action by the European Union last fall, which has angered Beijing and worsened China-EU relations.

  • Now that Chinese EV makers have begun to make ultra-cheap, high-quality cars (aided by government subsidies and protection), their EV exports are rapidly rising and posing what could be an existential threat to automakers in the developed countries.
  • With the threat of massive job losses in their auto sectors, the EU and the UK are therefore taking steps that will likely lead to tough restrictions against the Chinese. Along with the existing US restrictions on Chinese vehicles, that could eventually lead to excess capacity in China’s EV industry, which would further weigh on Chinese economic growth in the coming years.

Russia:  The Financial Times carries an article today describing what it says is a series of secret Russian military documents on the country’s policies for when it would use tactical nuclear weapons in a conflict.  The report suggests Russia’s threshold for using tactical nukes is lower than previously thought, including numerical standards such as the loss of 20% of its nuclear ballistic missile submarines.

  • We are still analyzing the article, so our view on its implication may still evolve. Nevertheless, it appears that the documents’ scenarios for going nuclear are fundamentally defensive.  For example, one scenario is if an adversary has invaded Russian territory and Russian conventional forces are unable to stop it.
  • Of course, it’s always useful to ask oneself: “Why is this being reported now?” It could well be that this is a leak designed to influence the current US and European debate over the future threat from Russia if it can consolidate its invasion of Ukraine.
  • Regarding the war in Ukraine, we believe the stalemate that seemed to be evolving late last year is now shifting toward an advantage for the Russians. With Western aid to Kyiv faltering and Ukraine struggling to field the requisite manpower, equipment, and ammunition to fight effectively, it looks increasingly like Ukraine’s defenses are becoming brittle and could soon fail, allowing the Russians to sweep westward.

United States-European Union-Russia:  European Commission President von der Leyen today formally proposed that the Group of 7 countries use profits from the $300 billion or so of Russian foreign reserves that they have frozen to support Ukraine in fighting off Russia’s invasion.  The formal proposal, which is also supported by the US, comes despite a lack of consensus among the allies over the legality of doing so and how it could be done.

  • Recent proposals have called for designating the frozen Russian assets as collateral to support G7 loans to Ukraine for its war effort and rebuilding, based on the idea that Russia will eventually owe reparations to Ukraine. The expected Ukrainian default would then result in the Russian assets being confiscated.
  • Despite the machinations being considered, the confiscation of Russian assets at the end of the day would not only be a major provocation against Moscow, but it would likely accelerate the loss of the US dollar’s status as the world’s reserve currency. Countries in the China/Russia geopolitical bloc and any other nations worried about crossing the US would have an even greater incentive to reduce or end their use of the greenback, with unpredictable consequences for the world’s financial system.

US Politics:  In yesterday’s Michigan presidential primary elections, former President Trump handily beat former UN Ambassador Haley again in the Republican contest, and President Biden won the Democratic one, but the protest votes on each side were large.  In the Republican contest, Trump won 68.2% to Haley’s 26.5%.  In the Democratic ballot, Biden won 81.1% against an “uncommitted” vote of 13.3%.

  • It increasingly looks like Trump and Biden will have a rematch in the November general election. Nevertheless, we still think that age and other potential issues could ultimately keep one or even both of the candidates off the ballot.  On top of that, a close race exacerbated by a potential third-party candidate could throw the election into Congress, with very unpredictable consequences.
  • At the end of the day, this election season is looking unusually chaotic and hard to call. It would not be a surprise if the unpredictability at some point begins to weigh on the financial markets.

US Fiscal Policy:  After a meeting with President Biden at the White House yesterday, Republican and Democratic congressional leaders expressed confidence they would soon reach a new funding deal that would avert a partial shutdown of the federal government when the current stopgap law expires Friday night.  However, Senate Majority Leader Schumer, a Democrat, warned that the likely solution would be yet another short-term funding package designed to give the two parties time to agree on funding for the remainder of the fiscal year.

  • Despite the optimism expressed by the lawmakers yesterday, neither a short-term nor a full-year deal can be assured, especially given the existence of a large body of Republican deficit hawks in the House who seem willing to torpedo any deal that doesn’t meet their aggressive goals for spending cuts.
  • In any case, yet another stopgap measure and a further delay in passing funding for the rest of the fiscal year through September will impinge even more on the US military’s effort to rebuild and expand to meet the growing threat from the China/Russia geopolitical bloc.

US Antitrust Policy:  In another sign that the administration is trying to tighten antitrust policy, the Justice Department has reportedly opened an investigation into health insurance giant UnitedHealthcare.  The probe appears to be focused on the relationship between the company’s insurance operations and its Optum health-services operation.  It isn’t clear whether the probe will lead to an antitrust lawsuit.  As we mentioned in our Comment yesterday, the administration has had a mixed record in antitrust because of the prevailing Bork Standard in the courts.

US Economic Growth:  The National Association of Business Economists said its updated US economic forecasts now show gross domestic product growing 2.2% in 2024, up sharply from its December forecast of 1.3%.  The improved growth would reflect better-than-expected increases in personal consumption expenditures, corporate and residential investment, and government spending.  The forecasts also call for lower unemployment and price inflation, which should allow the Federal Reserve to start cutting interest rates in Q2.

US Cryptocurrency Market:  Just weeks after financial firms won regulatory approval to launch exchange-traded funds holding bitcoin, reports say about 10 companies have now filed applications to offer ETFs holding ether, the second-biggest cryptocurrency.  In response to the news, ether prices have surged approximately 42% so far this month.  That has given a further boost to bitcoin prices, which are now up about 33% in the month to date.

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