China Risk is Potentially Far More Than a Trade War; What is the Fed’s Real Goal?

By Victor Sperandeo with the Curmudgeon



Introduction (Curmudgeon):

While the trade war with China is continuing, many may have missed a new threat from China:  the possible invasion of Hong Kong to quell the protests and unrest there.  Last Wednesday, a senior Chinese official in charge of Hong Kong affairs warned that Beijing would intervene if the local government proved unable to contain the violent protests, the most explicit threat of intervention to date from the central government.

At a meeting with Hong Kong representatives in the nearby city of Shenzhen, the official, Zhang Xiaoming, issued a dire assessment of the situation in the territory after more than two months of protests. He called the situation the most severe since China resumed sovereignty over Hong Kong in 1997.

“If the situation worsens further, and there is turmoil that the Hong Kong government is unable to control, the central government absolutely will not just watch without doing anything,” Mr. Zhang, director of the Hong Kong and Macau Affairs Office of China’s State Council, said in remarks carried by official state media.

China has in recent days expressed its concern that the protests were spiraling out of control and challenging China’s sovereignty over the territory, a former British colony that has limited autonomy under Chinese rule. The demonstrations started as protests against an extradition bill proposed by the local government but have turned increasingly violent and pointedly critical of Chinese rule, with protesters targeting the national flag and state seal.

Mr. Zhang’s warning of intervention was more direct than in recent days when officials signaled that Beijing’s patience was wearing thin. A day earlier in Shenzhen, more than 10,000 mainland China police officers ran through anti-riot drills, a video of which was circulated widely online as a show of force.


We have pointed out many risks over the years in Curmudgeon posts.  Few paid attention. The key to understanding real risk is that it has to be something the Central Banks cannot do anything about it. That implies geo-political risk that could precipitate an invasion or war.

Over the last 10 weeks, over 1 million Hong Kong (HK) residents have gone into loud and vast protests, mainly due to a proposed Chinese law that would force extradition to Beijing to be tried for certain (political) crimes.  That would end their liberty and institute tyranny in HK.   Carrie Lam, HK Chief Executive since 2017 (and a Chinese pawn), withdrew the extradition bill after 2 million people rallied in the streets against it.  However, she did not kill it. 

As a result, the protests continued with XI Jinping, President of China for life and Head of the Communist Party threatening the Hong Kong people with harsh punishments almost daily (see Introduction above).

Memories of the 1989 Tiananmen Square massacre are vivid in Asia’s mind, where a reported of 800-8000 Chinese protesters were killed, although the official number reported by the Chinese government was 241. No one knows the real death toll, but a secret British cable put it at least 10,000 people.

China’s President XI has a real dilemma to deal with, which may literally affect the whole world.  If he allows the protests to continue, he may cause contagion to the China mainland, where hundreds of millions of Chinese (total 1.4 Billion population) may start to make demands of freedom. If he sends the People’s Liberation Army (PLA) into HK [1], and they start killing ~100,000 HK protestors, that would cause the end of China trade as you know it.

Note 1. The HK army has 2,285,000 active frontline personnel with 2,300,000 in reserves.

Meanwhile, demand for physical gold in mainland China at the retail level is so extremely strong that many people do not mind paying the reported 7% premiums above spot prices there. Also, there are reported to be developing shortages of gold bullion in mainland China at the retail level.  Check out this YouTube video for more details, insight and perspective.


China’s Future and What Might Happen in HK:

China’s future is partially based on the “Belt and Road Initiative” (BRI), which is a global development strategy adopted by the Chinese government involving infrastructure development and investments in 152 countries!  "Belt" refers to the overland routes for road and rail transportation, called "the Silk Road Economic Belt;" whereas "road" refers to the sea routes, or the 21st Century Maritime Silk Road. It is estimated to cost just under $1 trillion a year for the next 10 years.

If the Chinese PLA [2] kills innocent protesters, who are totally unharmed (selling guns in HK is a Capital Crime), the end of this long term BRI plan would be in question, as many nations would not deal with mass murdering communist oppressors.

Note 2. The PLA carry fully automatic rifles (e.g. QCW 5.8 suppressed sub-machine guns).

But what if China’s Communist authority is questioned? One observation that President Trump is learning from the trade negotiations is that the Chinese don’t back down, and they don’t bluff!

It appears the HK people are willing to die for autonomy from China and democracy within HK, as the law prescribed in 1997 ("One Country, Two Systems") when China obtained control of HK and Macao from Britain.

This will be an important an interesting development. It also raises huge questions for Macao and Taiwan (both claimed to be an integral part of China, but Taiwan government doesn’t accept that)? 

·       If China sends troops and many people die, I suggest China (and the world economy) will suffer greatly. The Renminbi (RMB) aka Yuan will spike to 9-10 from the current 7 RMB=$1.00.

·       Gold will hit $1800 fast.

·       Equity Markets across the world will be down 20-25%.

·       U.S. Bonds will make all-time highs in price (lows in yield).

·       Oil will go below $50 towards $40 and stay there.

·       The dollar should decline (?), but that is a question I don’t feel with confidence. I do know the world will be much different than it is today.

ALTERNATIVE VIEW (Victor):  Does anyone really care if China was to invade HK?

The world does not care about HK, only themselves, and would not dare hurting their own economies to rattle let alone condemn China.  It’s possible... as everything these days is about “power.”

I say this because a trader I respect offers great skepticism of the world and the people. He could be right and I am wrong. You all can form your own opinions here. World leaders love condemning people who have no effect on them. But everyone does business with China? Would they stop doing business?

If one wishes to understand XI’s mind I suggest readings from Chairman Mao Zedong.  I’m told by a historian and brilliant Chinese philosopher, who grew up in Beijing, that XI Jinping’s idol was Mao who stated: “Every Communist must grasp the truth - Political power grows out of the barrel of a gun."  This is a slogan popular among Marxist-Leninist-Maoists.


COUNTER-POINT from Geopolitical Futures: Mainland China’s government does not seem to feel compelled to intervene Tiananmen-style in Hong Kong

Spokespersons for China’s Hong Kong and Macau Affairs Office gave a fairly bland press conference on Monday, repeating some platitudes about how bad the demonstrations are for Hong Kong and scolding foreign countries that have criticized China over the protests. That is remarkable on the face of it. One of the primary roles of the Chinese state is to maintain social harmony. A Chinese state that is unwilling or unable to ensure social harmony will not remain in power for very long. But this Chinese state is neither of those. This is a Chinese government that has elevated Xi Jinping to the de facto position of emperor-in-chief and is busily attempting to remake Uighurs in the image of the Han via “reeducation camps.” China is not intervening in Hong Kong because it chooses not to.  


For the past 10+ years, normal risk of economic and financial market weakness has been subverted by ultra-easy monetary policies pursued by the Fed and Global Central Banks.  In the past week, Australia, New Zealand, India, and Thailand all cut short term interest rates.

On August 7th, the Reserve Bank of New Zealand (RBNZ), cut its short-term rates 33% - or by 50 bps -from 1.5% to 1.00%.  RBNZ was unique in stating WHY it was cutting rates by one third, without the usual made up excuses, like from Fed Chairman Powell) about a “mid-cycle adjustment.” The RBNZ stated reality in listing the specific reasons for their rate cut:

“Inflation is below target; GDP is slowing; Employment outlook is also slowing; Global economic conditions weakened.”                            

It is almost surreal to read a Central Bank saying something honest for a change. This is the issue that the U.S. Fed has verbally ignored since at least late last year.

It may be interesting to note that from 1926 to date the spread between 30-year U.S. Treasury bonds and one-month T-Bills was 213 bps. U.S. Bonds compounded at 5.47%, while 30-day T-bills compounded at 3.34%.

Today, long term bonds yield 2.25% and one-month T-Bills yield 2.05% for a spread of 20 bps or 11 times lower than the 93-year norm?                                                                                  

It takes a deaf, dumb, and blind man (or a lying fool fed official) to not see something is terribly wrong with this rate comparison.  Not to mention, the U.S. has an inverted yield curve: The Fed funds rate is 2% bid, while the 10-year T-note yield is 1.72%.  The FOMC obviously has a different agenda than the country or what they say in public.

What about Inflation? The Commodity Research Bureau Index (CRB Index) made a yearly low (-1.12%) this week on August 7th.  That is a low going back to August 2017.   The Fed’s preferred inflation gauge is the Core PCE Price Index, which excludes prices of food and energy.  It increased 0.2% month-over-month in June of 2019 and 1.6% Year-over-Year.

Truly, all of the above begs the question: what is the Fed’s real goal?


Closing QUOTE:

Bill Murphy, Chairman of the Gold Anti-Trust Action Committee (GATA), says the market manipulators and price suppressers of gold and silver are fighting a losing battle. “Gold is at all-time highs in 73 different countries.”

Good luck and till next time……

The Curmudgeon

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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