Summary

Lots of market concern that some of the lessons of Russia & Ukraine should be applied to is China/Taiwan. What should the markets be watching here as it pertains to US strategy, Taiwan's vulnerabilities, or Chinese intentions?

Firm belief by policymakers that actions on Ukraine should not be compared to a potential global defence of Taiwan, though the sanctions “big guns” being rolled out right now—e.g., SWIFT cutoff, central bank restrictions, and the ‘foreign direct product rule’ prohibition on technology exports—do provide a template for economic warfare escalation. A problem is that Xi Jinping will be watching the events unfold, taking lessons from the global sanctioning of Russia, and we don’t know what the lessons are that he will draw from it.

How should investors view China's potential compliance on Russian sanctions?  You spend a lot of time working with the current administration -- how do they view this?  Will China adhere to the sanctions or will they look to play the role of spoiler?

As we all know, the so-called "phase 1" US-China trade deal has expired and as of yet the Biden policy hasn't laid out any successor plan.  Will this happen soon? What will it be?

China’s adherence to sanctions historically has been mixed. This is a complex situation, because secondary sanctions can pose a serious threat to key Chinese companies as well as the broader Chinese economy. After the initial bloodshed dies down, China will no doubt be more aggressive in tiptoeing around global and US sanctions, but a distinction should be drawn between lower level banking and other sanctions that Beijing may not take seriously and the bigger sanctions guns being rolled out now. The aforementioned foreign direct product rule – which requires anyone in the world, selling goods with US intellectual property, to a sanctioned entity, to have a license from the U.S. Commerce department—is a massively powerful trade tool that has now been expanded to the point where it will cut off nearly the entire Russian tech sector. This will make things far more dangerous for Chinese companies that risk getting tangled in crushing secondary sanctions. On the other hand, China will want something in return for their adherence, which we’re told will be a much tamer U.S. trade policy. The Biden administration has been working on finalizing a new section 301 investigation behind the scenes, as a follow up to the old phase-1 U.S.-China trade deal, which is now expired. The real question Leland is focused on is how much the U.S. will dilute a 301 investigation into China, as a quid pro quo for Chinese adherence to Russia sanctions, or even delay it indefinitely. This is the current debate raging between the White House and US Trade Representative.

Let's move on to the Chinese economy.  Your team has a well-documented track record for having predicted pretty much all the surprise twists and turns of Chinese economic policy the past 2 years, which is saying something since the old "growth playbook" is clearly no longer in play anymore.  What have you been seeing and what's going to happen next?

Coming out of lockdowns in 2020, CBB concurred with official data that there was a quick bounce back, led almost entirely by industry. But in 2021, the overwhelming market consensus was that China’s recovery would normalize and consumer spending would rocket back. Not only did that not happen, but CBB data in Q2-21 showed the worst retail sector data in their decade-plus history. In other words, contrary to predictions across Wall Street, there was never any evidence in the data that a consumer spending comeback was in the cards. And when that never happened, this panicked many China analysts and a new, overwhelming market consensus arose that Beijing would have little choice but to ramp up stimulus in order to compensate. Yet CBB never saw any hint of that coming, either. Financial de-risking took place throughout the entire year, and never let up. By Q2-21 there was also enormous property sector distress, evidenced by how almost half of property firms wishing to borrow were kicked out of the traditional banking system and forced into pricier shadow finance. Overall, Wall Street has seen its predictions one after another after another throughout 2020-21 whiff, as there doesn’t seem to be broad recognition that the economic growth playbook in China has changed. This is further evidenced by the CCP’s changing of the social compact, whereby it is now pledging to deliver slower levels of growth but in return promising a healthier economy and a stronger country. Leland’s overall view is that it is no longer impossible to use the old growth and stimulus playbook to forecast the economy, that era is over. Investors must use real, actionable growth, credit and jobs to understand what is actually happening on the ground.

Let me ask about China Beige Book's new February data, which I believe was just released Monday morning.  Big picture and sector wise, what did you see?

January data looked bad, with growth deteriorating further and credit conditions even tighter. However, February showed some improvement in key areas. Manufacturing and services surprisingly rebounded, although retail, even YoY, looked terrible. Borrowing and loan demand jumped for the first time in a long time, suggesting enhanced monetary stimulus may finally be on its way in the not distant future. All this suggests March data—out less than 3 weeks from now—are going to be the most important China economic data in a long time.

Could you touch on China’s changing stance on Covid-Zero Policy?

Based on proprietary tracker, Covid levels in China are currently far beyond what the government is admitting to--though nowhere near crisis levels, even with the ramp up in Omicron transmissibility. CBB has also seen a fascinating divergence in cases amongst coastal cities, suggesting that the further away from Xi Jinping, the higher their reported Covid numbers, but also the better their economic performance because of the diminished frequency of severe lockdowns. It’s a fascinating pattern that regional breakdowns suggest are meaningful. In terms of rethinking the Covid Zero policy, now is the time if there ever was one. The Beijing Olympics are now over, so there is a period between now and the run-up to the Party Congress this summer where the Chinese government has a window to rethink its strategy.

The big question for markets is always about stimulus.  Are you seeing any signs of this yet?  Why has most of Wall Street gotten this call so incredibly wrong for the past 6 months?

Until February, despite all the noise, there was no real evidence that meaningful easing had begun. Headlines claimed it and Wall Street research shops told clients to rush into Chinese equities anticipating that it had to be imminent, but this was all made-up. CBB is now seeing some evidence of this beginning, with upticks in credit access in certain key areas, including the property sector, while loan applications are now creeping up, loan rejections down, and pent-up loan demand from firms cranking up as well. All growth-positive. March data will be critical in confirming whether or not there has finally been a meaningful pivot.

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