Weekly Geopolitical Report – The Evolving U.S. Policy Toward China and Its Impact on Investors (August 10, 2020)

by Patrick Fearon-Hernandez, CFA | PDF

Looking forward to the coming years and decades, today’s long-term investors face a stark question: will they be investing in a China-dominated world molded by authoritarian leaders in Beijing?  Or, will they be investing in a more familiar, Western-dominated environment reflecting the historic leadership of the U.S. and incorporating the values of freedom, private property, and justice, as handed down from British common law?  Here at Confluence, we have long discussed the global public goods of security and a reserve currency that the U.S. has provided in its traditional role as global hegemon, and we’ve shown that U.S. citizens have become tired of providing those goods.  We’ve argued that the most likely future is one in which the U.S. relinquishes its global dominance, producing an unstable and dangerous transition period from which some new hegemon—perhaps China—will eventually arise.

But the end of U.S. hegemony and its replacement by China are not yet set in stone.  High-level “China hawks” in the Trump administration have launched an audacious effort to convince the American people and America’s foreign allies that they must push back against China and its effort to assume the throne of global leadership.  At the dawn of the Cold War, the architects of U.S. “containment policy” faced a similar challenge as they built the case for thwarting Soviet expansionism.  The question now is whether the new tough-on-China argument will resonate to the same extent.

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Weekly Geopolitical Report – Rethinking China: Part II (August 3, 2020)

by Bill O’Grady | PDF

In Part I, we described China’s situation using Japan as a historical analog.  This week, we will complete the analogy and examine in some detail the potential motivations of Chinese and U.S. policymakers. As always, we will conclude the discussion with potential market ramifications.

China’s Situation
Similar to Japan in the 1930s, China has become a large economy showing geopolitical power that is threatening the established order.  Similar to Japan in the 1980s, it has an economy overly reliant on investment, trade and debt.  And, like Japan, it is dependent on sea lanes it does not control.  Finally, as was the case with Japan during both the 1930s and 1980s, China has reached a point where the U.S. is refusing to accommodate its rise.  However, unlike Japan, China is not as dependent on the U.S. for its security (although it is quite vulnerable to a blockade).

It is arguable that Deng realized China would eventually reach this state and thus encouraged Chinese leaders to bide their time.  Simply put, Deng wanted to extend China’s ability to stay “under the radar” for as long as possible before it would inevitably trigger a response from the U.S.

It is important to realize China is not acting in a vacuum.  The U.S. has a clear role in how this situation evolves.  The American response to China’s rise appeared to be guided by two principles.  The first is that eventually China would accept U.S. hegemony and the trading system America had created after WWII.  The second was that communism was fundamentally flawed and China would eventually develop into a capitalist democracy.

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Weekly Geopolitical Report – Rethinking China: Part I (July 27, 2020)

by Bill O’Grady | PDF

President and General Secretary Xi Jingping has changed the course of Chinese governance.  Deng Xiaoping Peng created a collective leadership model to prevent the rise of another Mao.  Leaders were carefully selected and surrounded by leading figures of the various factions of the Communist Party of China (CPC).  Term limits were put in place to restrict a President/General Secretary to two five-year terms. Deng established a structure of government which was somewhat decentralized.  Cults of personality were discouraged.

Xi Jinping has reversed these measures.  He has ended the restrictions on term limits.  The Standing Committee of the Politburo is mostly composed of allies.  Instead of using the structure of government that diffused power, Xi has created a series of informal committees that actually execute policy; this gives him nearly complete control of the government.  “Xi Jinping thought” is now discussed in party and academic circles; although no one has bound them into a little red book, it would not be a surprise if that were to occur.

Xi is also changing China’s foreign policy.  Under Deng, foreign policy was all about “hide your ambitions and disguise your claws.”  Under Xi, foreign policy has been more assertive.  However, over the past 18 months, we have seen aggressive and, perhaps more importantly, widespread actions.  China seems to be willing to create tensions across a broad spectrum, which does appear to be a new development.

There are two broad themes to this report.  In Part I, we will frame China’s situation using Japan as an analog.  In Part II, we will continue the analog, discuss recent Chinese aggression and offer a detailed analysis of the potential motivations of Chinese and U.S. policymakers.  As always, we will conclude the discussion with potential market ramifications.

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Weekly Geopolitical Report – Why China and India Are Fighting (July 13, 2020)

by Patrick Fearon-Hernandez, CFA | PDF

In a bizarre confrontation last month, Chinese and Indian soldiers fought a pitched battle in near total darkness high up in the Himalayan mountains.  If that wasn’t strange enough, the weapons used were merely fists, stones, police batons, and wooden clubs wrapped in barbed wire or studded with nails.  At least 20 of the Indian soldiers died, many after falling down steep mountain ravines or freezing to death in the cold.  An unknown number of Chinese troops also died.  In spite of the primitive weapons used and the relatively small number of casualties, the skirmish created a major crisis and risk of war between Asia’s two nuclear behemoths.

In this report, we explain how the confrontation came about and why it was waged in such a primitive way.  More importantly, we examine the tensions building between China and India and how the skirmish could cause them to spiral out of control.  We also outline how things could develop from here and the likely ramifications for investors.

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Weekly Geopolitical Report – The U.S.-China “Phase One” Trade Deal: Part II (February 3, 2020)

by Bill O’Grady

In Part I of this report, we offered a detailed examination of “Phase One” of the recent trade agreement between the U.S. and China.  This week, in Part II, we will examine the ramifications of the deal and conclude the report with market effects.

China appears to be the “loser” in this deal.  Our careful reading of the report does support the notion that China gave up more than it got in this arrangement.  All leaders of governments try to avoid looking weak; Chinese leaders especially worry about appearing fragile to avoid comparisons to the Opium War era.  So, if this take is accurate, what led to this outcome?

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Weekly Geopolitical Report – The U.S.-China “Phase One” Trade Deal: Part I (January 27, 2020)

by Patrick Fearon-Hernandez, CFA

After months of negotiations, the U.S. and China signed “Phase One” of what is expected to be a multiple-phase trade deal.  After noting media response to the agreement, we were struck by the dismissive consensus narrative that has developed.  Our careful review of the document seemed to suggest a much more substantial arrangement had been struck and the general analysis missed a good deal of nuance.  In this report, we will offer a detailed recap of the official agreement.  We usually don’t engage in this sort of point-by-point analysis but, in this case, we feel it is necessary because points may have been overlooked.  Next week, in Part II, we will examine the implications of the deal, and, as always, close with market ramifications.

Intellectual Property
Even though President Trump has touted China’s commitment to ramp up U.S. imports under the deal, and media analysts have emphasized the U.S. promise to postpone or roll back its tariffs against China, the first 16 pages of the 94-page agreement focus on protecting intellectual property.  That suggests U.S. Trade Representative Lighthizer’s top priority was to rein in China’s longstanding efforts to soak up foreign technology and industrial secrets by hook or by crook.  It probably also signals the U.S. intention to pursue fundamental changes in China’s legal system and industrial structure over time.  The key provisions agreed upon include:

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Weekly Geopolitical Report – The 2020 Geopolitical Outlook (December 16, 2019)

by Bill O’Grady and Patrick Fearon-Hernandez, CFA

(This is the last report for 2019; the next report will be published January 13, 2020.)

As is our custom, in mid-December, we publish our geopolitical outlook for the upcoming year.  This report is less a series of predictions as it is a list of potential geopolitical issues that we believe will dominate the international landscape for 2020.  It is not designed to be exhaustive; instead, it focuses on the “big picture” conditions that we believe will affect policy and markets going forward.  They are listed in order of importance.

Issue #1: U.S. 2020 Presidential Election

Issue #2: Iran

Issue #3: China’s Debt

Issue #4: Demographics

Issue #5: North Korea

Honorable Mentions…

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Weekly Geopolitical Report – The Mid-Year Geopolitical Outlook (June 24, 2019)

by Bill O’Grady

(Due to the Independence Day holiday and a short summer hiatus, the next report will be published July 15.)

As is our custom, we update our geopolitical outlook for the remainder of the year as the first half comes to a close.  This report is less a series of predictions as it is a list of potential geopolitical issues that we believe will dominate the international landscape for the rest of the year.  It is not designed to be exhaustive; instead, it focuses on the “big picture” conditions that we believe will affect policy and markets going forward.  They are listed in order of importance.

Issue #1: Deglobalization

Issue #2: Election Meddling

Issue #3: Iran

Issue #4: China

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Weekly Geopolitical Report – The 2019 Geopolitical Outlook (December 17, 2018)

by Bill O’Grady

(N.B.  This will be the last WGR of 2018.  Our next report will be published January 7, 2019.)

As is our custom, we close out the current year with our geopolitical outlook for the next one.  This report is less a series of predictions as it is a list of potential geopolitical issues that we believe will dominate the international landscape in the upcoming year.  It is not designed to be exhaustive, but rather it focuses on the “big picture” conditions that we believe will affect policy and markets going forward.  They are listed in order of importance.

Issue #1: China

Issue #2: European Politics

Issue #3: Rising Western Populism

Issue #4: Saudi Succession

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