Trump on trade: unintended consequences?

A straightforward analysis of what Mr. Trump is doing would be:

–tariffs slow overall growth and rearrange it to favor protected industries.  There’s no reason I can see to believe something different might happen in the US

–apart from the third world, protected industries tend to have domestic political clout but to be in economic trouble.  In my experience, these woes come more from bad management than from foreigners’ actions

–the go-it-alone approach is a weak one, since it provides ample scope for a target country to shop tariffed goods through an intermediary

–the apparently arbitrary way the administration is acting will cause both domestic and foreign corporations to reconsider future capital investment in the US.

 

There are, however, two other issues that I think have long-term implications but which aren’t discussed much.

–tariffs may cause industries that have moved abroad to retain labor-intensive work practices (and continue to use dated industrial machinery) in a lower labor-cost environment to return to the home country.  If such firms come back to the US, it won’t be with the old machinery.  New operations will be very highly mechanized. In other words, one likely response to the Trump tariffs will be to accelerate the replacement of humans with robots in the US.

–as I see it, China is at the key stage of economic development where, to grow, it must leave behind labor-intensive work and develop higher value-added industries.  This is very hard to do.  The owners of low value-added enterprises have become very wealthy and powerful.  They employ lots of people.  They have considerable political influence.   And they strongly favor the status quo.  The result is typically that the economy in question plateaus as labor-intensive industries block progress.  In the case of China, however, the threat that the US will effectively deny such firms access to a major market will kickstart progress and deflect blame from Beijing.

 

If I’m correct, the effect of trying to restore WWII-era industry in the US will, ironically, achieve the opposite.  It will accelerate domestic change in the nature of work away from manual labor.  And it will run interference against the status quo in China, allowing Beijing’s efforts to become a cutting-edge industrial power to gather speed.

 

 

slowdown in China

In the late 1970s Deng Xiaoping was forced to tackle the gigantic mess that central planning had made of the Chinese economy during Mao’s rule.  The problem:  highly inefficient, loss-making, corruption-infested, Soviet-style (feel free to add more negative, hyphenated adjectives) state-owned enterprises dominated the industrial base.  The products were poor;  the books more fiction than not.  Deng’s solution was to adopt Western-style capitalism under the banner of “Socialism with Chinese Characteristics.”  This meant pulling the plug on bank credit and political favor for state-owned enterprises and redirecting support toward the private sector.

The result has been 30+ years of economic growth so strong that it has vaulted China from nowhere into first place among world economies.  In fact, the PRC is now 10%+ larger than #2, the US, using Purchasing Power Parity as the yardstick.

According to an astute observer of China, Nicholas Lardy, writing in the Financial Times, however, current Chinese leader Xi Jinping has not simply been cracking down on the cumulative excesses of the private sector over the past couple of years.  He has also reversed Deng’s policy in favor of building up the state-owned sector again.  Lardy thinks this decision is reducing China’s annual GDP growth rate by a whopping two percentage points.

I’m not sure why this is happening.  But for China, the highest economic principle has never been about achieving maximum sustainable GDP growth.  Rather, it’s whatever is necessary to maintain the Communist Party in power.  Reduction in GDP growth is a secondary concern.

 

I don’t know how this affects China’s stance in tariff negotiations with the US, especially since White House economists seem to be suggesting that the US economy is already beginning to contract under the weigh of current tariffs plus the government shutdown   (increased tariffs slated for March will only deepen any decline).  From a longer-term point of view, though–and assuming Chinese policy doesn’t change–for a company to simply have exposure to China will no longer be any guarantee of success.

 

internet companies vs. state-owned enterprises in China

Recently Beijing announced it wants to take equity positions in the major internet companies in China and place Communist Party officials on their boards of directors.

What’s going on?

I see two general possibilities.

Some background first.

Deng’s economic reform

In the late 1970s, Deng Xiaoping realized that the Chinese economy was too big to be controlled through central planning.   To grow it had to adopt Western economic (but not political) methods.  So he began to allow the market, not doctrinally-correct political cadres, to dictate the direction of expansion.

A major issue he faced in doing so was that, say, three-quarters of Chinese industry was owned by the state.  These companies were rudderless, and hopelessly inefficient–but they employed tons of people.  If large numbers lost their jobs all at once, the ensuing social instability might threaten the rule of the Party.  Therefore, economic progress had to be tempered by the need to avoid this outcome.  And this in a nation without sophisticated macroeconomic tools to control the pace of growth.

The result over three+ decades has been a Chinese economy that lurches between boom and bust, depending on the temperature in the state-owned enterprises.  The strategy has generally been successful, I think, with the state-owned sector now representing less than a third of China’s overall output.

possibilities

–China’s internet companies have become large enough that their actions, intentional or not, can accelerate the speed at which state-owned companies shrink.  So they need to be monitored much more carefully than in the past.  This is the benign interpretation, and the one which share prices suggest the market has adopted

–China’s internet companies have become large enough to generate “creative destruction” in large enough amounts to threaten the economic control over China exercised by the Communist Party itself.  If this is the case, then the oversight over domestic internet conglomerates will be much more draconian than the consensus expects.  That would presumably result in considerable PE contraction for the firms being controlled.

My guess is that the first possibility is much more likely to be the case.  But I think we should watch the situation closely for new hints about Beijing’s intentions.

the curious case of Toshiba and the Mitsui keiretsu

The Financial Times, now owned by the Nihon Keisei Shimbun (the Nikkei)–and which should therefore have a particularly sharp insight into goings on in corporate Japan, had an interesting article the other day about Toshiba.

Toshiba is facing possible bankruptcy and potential delisting from the Tokyo Stock Exchange as a result of the disastrous performance of its nuclear power business.  To avoid this fate, it has decided to sell its flash memory business, which is a world leader in this important class of semiconductor devices and owns essential intellectual property for their manufacture.

The Japanese government is intervening in the matter, with the aim of ensuring that this important asset remains in Japanese hands.  What is distinctly not happening, as pointed out in an FT article two days ago, is any aid being offered by other members of the Mitsui industrial group.  This is very unusual.

background

At the core of Japanese economy in the first half of the twentieth century stood a number of powerful industrial conglomerates, called zaibatsu, which emerged from the samurai culture of shogun-era Tokyo.  The zaibatsu were outlawed after WWII for their role in Japan’s participation in that conflict.  But their dissolution was in name only.  The groups continue to exist in substance but were referred to as keiretsu.

One of the principal features of the keiretsu is mutual assistance in times of trouble.

For example,

Some years ago, Mistubishi Motors tried to buy its way into the US car market with a “0-0-0” financing campaign.  That meant zero down, a zero interest rate on 100% financing, and no loan repayment for the first year.  As it turned out, there was also a fourth zero–no credit checks.  And very large number of buyers (if you can call them that) simply made no payments when the time came.  They continued to drive the cars until they were repossessed.  Mitsubishi Motors as a whole, not just the US subsidiary, was faced with financial failure as a result.

What happened?

The other members of the Mitsubishi group injected hundreds of billions of yen into the auto company so that it remained afloat.  I remember speaking about this at the time with the chairman of Mitsubishi Corp, the group’s trading company.  He was deeply unhappy about having to invest in the auto arm of the group, and knew that this made no economic sense, but felt that his honor demanded that he do so.

today

Fast-forwarding to today and Toshiba     …not a peep from other Mitsui group members.

There may be something unusual about Toshiba.  More likely, the zaibatsu concept, a vital aspect of the samurai culture, may have finally passed its best-by date.  Interesting, too, that this should come while a descendant of the samurai is the prime minister.

Chinese economic growth

China, the largest economy in the world (by Purchasing Power Parity measurement), reported 1Q17 economic growth of 6.9% earlier today.  The best analysis of what’s going on that I’ve read appears in the New York Times.

The bottom line, though, is that this is a slight uptick from previous quarters–and good news for the rest of the world, since one of the big factors that is driving growth is exports.

Traditionally, the first question with Chinese statistics has been whether they attempt to represent what is happening in the economy or whether they’re the rose-colored view that central planning bosses insist must be shown, whatever the underlying reality may be.

I think this is a much less worrisome issue now than, say, ten years ago.  But in addition to greater faith in statisticians, we also have other useful indicators about the state of China’s health.  They’re all positive:

–As I wrote about a short while ago, demand for oil in China is rising.

–Last week, port operators reported an activity pickup, led by exports.

–And Macau casino patronage, which bottomed last summer, is showing surprising increases–with middle class customers, not wealthy VIPs, in the vanguard.

While I think that consumer spending in the US is probably better than recent flattish indicators would suggest (on the view that statistics are catching all of the pain of establishment losers but much less of the joy of new retail entrants), my guess is that increasing export demand for Chinese goods is coming from Continental Europe.

More tomorrow.

Shenzhen Connect starts next week

…on December 5th.

That’s according to the Hong Kong Exchanges and Clearing Limited (HKEX), whose Stock Exchange of Hong Kong subsidiary signed an agreement with its Shenzhen counterpart on rules for Shenzhen Connect last month.  The agreement was just approved by mainland Chinese regulators.

what is Shenzhen Connect?

It’s a mechanism that allows investors in Hong Kong to buy or sell Shenzhen-listed stocks, up to a specified (but large) total daily limit.  It also allows China-based investors to buy and sell Hong Kong-listed stocks through the Shenzhen Exchange.

The start of Shenzhen Connect trading follows the successful establishment of a similar arrangement between Hong Kong and Shanghai, called Stock Connect, a little more than two years ago.

significance?

In a practical sense, Shenzhen Connect and Stock Connect together end the closed nature of the Chinese stock market.  Doing so is an important economic objective of Beijing.  It’s another step down the road to dismantling the central planning and control that has characterized Chinese socialism since WWII.

rising Shenzhen shares?

Will this signal a boom in Hong Kong interest in China-listed shares?  I don’t think so, but it will be interesting to watch and find out.

Stock Connect, which opened the Shanghai stock market to foreigners wasn’t such a big deal, in my view.  That exchange is dominated by state-controlled banks and by stodgy old industrials headed mostly by state functionaries with no idea of how to run a profitable business.  Beijing will protect the banks but is content to let the  gradually wither and die.  So I didn’t see any rush to be the first foreigner to arrive in 2014.

The Shenzhen Exchange, on the other hand, is home to much more entrepreneurial firms, with little or no official state involvement.  So, in theory, yes, I might want to participate.

A big roadblock for me, though:  I have no idea whether I can trust the financial reports that companies issue.

Two ways to find out: listen carefully to what local players say and do; and visit the companies that sound interesting, interview the managements–and then watch to see how what they say matches up with operating results and what the financials report.

Even then, my experience is that you may not be safe.  Years ago, I visited a small Hong Kong manufacturing company at the urging (I didn’t need much) of a friend.  The firm told me a fabulous story of its success making computers for children.  I went back to see the management some months later.  They didn’t recognize me as a person they’d spoken with before.  This time they told me an equally dollar-sign-filled story, but this time they were an auto parts firm.  Whoops.

I’m not willing/able to put in the effort required to understand how the stock market game is played in Shenzhen.  So, Shenzhen Connect won’t tempt me away from the sidelines.

 

 

developments in Macau gambling

Today’s Election Day.  Be sure to vote.

I think the results of the presidential election may have far-reaching effects on the US economy and stock market, with a Trump victory being especially bad.  But that’s a topic for another day.

 

There are three recent developments of note in the Macau casino gambling market, one whose recent decline I badly underestimated:

–after peaking at a monthly gambling win of MOP 30.7 billion (US$3.8 billion) in February 2014 and beginning negative year-on-year comparisons that June, the market finally bottomed in June 2016.   Win for that month was MOP 15.9 billion (US$2 .0 billion); yoy comparisons turned positive in August.  An obvious plus.

–18 marketing employees of Australia’s Crown Resorts were detained in China last month.  Their crime appears to be offering., while in China, larger-than-permitted inducements to Chinese high rollers to visit Crown Resorts properties in Australia.  Since Crown also has casino operations in Macau, however, it’s not 100% clear that this is the issue.  A similar situation occurred in 2015, when marketers for casinos in Korea offered illegal inducements in an effort to get high rollers to visit.  For the moment, at least, this has marketers for Macau erring on the side of caution.

It’s unclear whether this is good or bad for casino operators.  Running VIP gambling operations is all about controlling the cost of the rebates and amenities needed to get high rollers to commit to visit a casino and gamble a specified (large) amount.  In the past, Crown has initiated price competition in this arena.  At one point, the Macau government stepped in to set a cap on allowable rebates.  Whatever Beijing’s motivations, it may be having the same effect now.

–profits at existing Macau casinos generally have been surprisingly strong.  That’s both because of non-casino attractions like restaurants, shows and shopping, and the continuing strong evolution of a non-VIP market.  Two exceptions:  the Ho family legacy casinos and companies like Wynn Macau, which are opening substantial new capacity.  Contrary to what one might expect,new offerings are not immediately drawing gamblers looking for novelty.  Instead, the Macau experience has been slow but steady progress to full utilization, achieving that goal, say, a year after opening.

One other point:  Macau has been marching to its own drummer in stock market terms over the past couple of years, driven by the course of casino win.  That’s likely to continue   …but it will probably be a positive rather than a negative in 2017.  So Macau may act as a refuge in a time of choppy global markets.

(Note:  I own shares in Wynn Macau (HK1128) and Galaxy Entertainment (HK0027), as well as a tag end of a former Sands China (HK1928) position that I’ve mostly sold (and am not inclined at present to rebuy.))