China will be one of the few major markets to record economic growth in 2020. As the rest of the world continues to endure the symptoms of COVID-19, Beijing has seemingly been vaccinated against the coronavirus, thanks to a plethora of fiscal and monetary interventions. But if the world’s second-largest economy is on the rebound, how come it feels like the house of cards is about to come crashing down? It is because the nation is in a fragile state as the chickens come home to roost. Corporate America is escaping the red dragon, while Uncle Sam is giving Beijing the cold shoulder. China potentially has only one ally left in the world: Wall Street. Will it be enough to survive?
Wall Street Drunk on Baiju Kool-Aid
For the last 18 months, China has been adopting a series of market-oriented reforms. Some of these measures were being employed before the trade war with the United States, and others have been instituted as part of the provisions inside the phase one trade agreement. President Xi Jinping has allowed more of a foreign presence in the banking system, curbed many tight controls in the stock market, and opened up the capital markets to outside investors. This might not seem like much, but it is the biggest set of market reforms in 40 years when the central government de-collectivized agriculture.
At the beginning of the trade dispute with President Donald Trump, Vice Premier Liu He sought assistance with some of America’s most powerful executives, including JPMorgan Chase CEO Jamie Dimon and BlackRock Chief Executive Larry Fink. He asked for help in exchange for first dibs on new opportunities expanding into China.
It was a quid pro quo proposal. China can utilize some of the biggest names in finance to advance public policy pursuits in the United States. Wall Street can take advantage of the liberalization of trade, a population of 1.3 billion people, and a gross domestic product (GDP) of approximately $13 trillion. It is a match made in heaven. It was the start of a beautiful friendship.
However, considering the state of China’s finances, it may need outsiders more than ever before. The best way to achieve this? Open the front door to its capital markets for anyone who has cash.
As Liberty Nation recently reported, Chinese state-owned enterprises (SOEs) are facing a wave of debt defaults. Many government-controlled companies are failing to make payments on as much as $1 billion in bonds. This year, there have been more than 100 corporate bond defaults worth about $20 billion. For now, President Xi and his merry band of communists are not saving these entities from ruin, perhaps as part of efforts to show the rest of the world that Beijing is not doing business as quasi-socialist usual. But the scarcity of action could trigger unintended consequences.
Foreign direct investment (FDI) into China is nearing its pre-pandemic level of about $130 billion. In the January-to-October period, the FDI surged 6.4%, and there is little evidence to suggest this figure will not spike in 2021.
Should more SOEs crumble, it could cost provinces and municipalities more money to borrow on the capital markets since they can no longer guarantee their bonds. Foreign investors are still betting that the government will swoop in and give everyone some yuan. But it does not look like that is going to occur. Hope is not lost, however.
Over the last two months, China has invigorated its bond market and has already experienced record foreign flows into the $15 trillion arena. It has become a nubile prospect because of the yield: The benchmark 10-year bond, for example, offers a return of 3.33%. Contrast this with the 10-year U.S. Treasury yield of 0.97%. Should foreigners, particularly those from Wall Street, buy vast sums of government and corporate bonds, China can kick the can down the road and delay its inevitable collapse.
Throwing Caution to the Wind
Had President Trump not initiated a trade dispute and the coronavirus pandemic not infected 60 million worldwide, China could have kept the charade going a little longer. Like every other socialist nation, however, the laws of economics inevitably rear their ugly head and force the country to adapt or die. Beijing is now fouling off 100-m.p.h. fastballs to keep the inning alive, doing everything from embracing foreign investment to digitizing the yuan. What about the debt? Perhaps China is devising technology that allows you to ship off your obligations on a rocket to the moon, hoping for alien creatures to absorb the red ink. Hey, it is 2020, after all – anything is possible.
Read more from Andrew Moran.