SinoInsight 1
On May 31, China’s Ministry of Commerce announced that it would establish an “unreliable entity list” composed of foreign firms, organizations, and individuals. The entities named on the list are those that violate market rules and contracts, block or disrupt supplies to Chinese companies for non-commercial reasons, and harm Chinese business and national interests.
On June 2, China’s State Council information office published a white paper titled, “China’s Position on the China-U.S. Economic and Trade Consultations.”
The white paper makes these central points:
- The United States “backtracked” and “should bear the sole and entire responsibility” for the break in the trade talks;
- The U.S. tariff hike is “trade bullying” and does not benefit the American and global economy;
- The PRC denies all accusations of unfair trading practices made by the U.S. and backtracks on its admissions, including on issues like intellectual property theft and forced technology transfers;
- The PRC accuses America of being an “untrustworthy negotiator”;
- The PRC stresses that it would not compromise on “issues of principle” and is “prepared to respond to any challenge”;
- The PRC believes that “China’s economic prospects are very optimistic” and it will continue to carry out “reform and opening up.”
OUR TAKE
1. The Chinese regime’s toughening stance toward America appears to be shaped by two factors. First, the CCP does not have effective countermeasures to use in an escalating trade war with the United States. Second, the CCP factional struggle impedes Xi Jinping’s authority and forces the regime to default to ossified, “politically correct” Party orthodoxy (i.e. when in doubt, leftism is always right) in handling growing tensions with America.
The PRC’s latest white paper backtrack will likely doom the negotiation option, deepen American distrust of China, and accelerate the escalation of Sino-U.S. tensions.
2. Many observers believe that Xi Jinping wields paramount authority in the Chinese regime and is virtually unchallenged in the Party. As one China watcher puts it, “Mr Xi need only snap his fingers and China’s government, legislature, media and banking system will do his bidding.”
Longtime SinoInsider readers, however, will know that Xi is nowhere near as powerful as popularly imagined; Xi’s five-year effort to consolidate power to a high degree is a sign of weakness, not strength. Also, the recent investigation of Xi confidant Liu Shiyu signals that Xi’s authority has been weakened as a result of his leadership’s failure to resolve trade issues with the United States. Lastly, but most crucially, many observers are mistaken in believing that the “collective leadership” model is no longer in practice after the 19th Party Congress. While there are incidents which suggest that Xi is more than “first among equals” in the Politburo Standing Committee (e.g. other PBSC members having to submit work reports to Xi), the term “collective leadership” has not been written out of Party propaganda. Put another way, “collective leadership” may have been de-emphasized, but it was never fully done away with by Xi or the Party.
Recent information indicates that the “collective leadership” is responsible for the CCP’s decision to take a hardline stance on America. According to a May 28 report by the South China Morning Post, Xi had “canvassed the other 24 Politburo members for their views on the latest US demands” in a May 13 meeting, and the Politburo “overwhelmingly decided that the Americans had gone too far and that China should put its foot down.”
We believe that Xi Jinping left the decision on how to respond to the latest U.S. tariffs to the “collective leadership” out of self-preservation. And out of self-preservation, the “collective leadership” defaulted to Party orthodoxy in deciding how the PRC should react to America. The Chinese regime’s recent activities—rousing anti-American sentiment; denying trade, IP, and other transgressions despite having admitted to them; acting as the innocent party in the trade conflict; pretending to be the defender of the rules-based international order; etc.—are all classic CCP behavior.
3. We believe that the U.S. will likely take the Chinese regime’s latest moves (entity list, white paper) as confirmation that the Party cannot be trusted and must be confronted with tougher measures. The Trump administration could abandon further trade talks and ramp up the rolling out of long-term strategies to contain the regime and curb the CCP threat.
SinoInsight 2
On May 24, the People’s Bank of China established Deposit Insurance Fund Management Co. Ltd., a company that will manage a 10 billion-yuan fund to protect depositors’ savings at financial institutions. Huang Xiaolong, the central bank’s financial stability bureau deputy head, will serve as the company’s legal representative and executive director. The Deposit Insurance Fund Management was set up on the day that financial regulators took over the running of Baoshang Bank.
From May 27 to May 30, the PBoC injected a net 430 billion yuan into the banking system through reverse bond repurchase agreements (cumulative 530 billion yuan; the net amount is due to the maturing of 100 billion yuan in reverse repos), the largest weekly fund injection in four months.
On June 2, a PBoC spokesperson said that there was “ample” medium- and small-sized banking liquidity while various liquidity indicators are at normal levels, according to the central bank-run financialnews.cn.
OUR TAKE
1. We believe that the PBoC’s recent moves are a response to the “severe credit risk” posed by medium- and small-sized Chinese banks. Also, the recent government takeover of Baoshang Bank suggests that the Sino-U.S. trade conflict is exposing long-standing problems in China’s financial system.
2. Baoshang Bank failed to release annual reports for 2017 and 2018. A May 29 article posted by “Securities China” (the official social media account of the state-run “Securities Times”) notes that aside from Baoshang, there are over 10 small banks that did not publish any annual or quarterly reports this year.
A financial regulator quoted in the Securities China article said that some rural and urban commercial banks are on the verge of “technical bankruptcy” due to “severe credit risks.” The so-called “technical bankruptcy” refers to banks being unable to repay debts due to a failure of “financial management skills.”
3. Medium- and small-sized Chinese banks rely on interbank borrowing for most of their funding. However, in the case of Baoshang Bank, the PBoC only guarantees personal accounts and interbank debts of less than 50 million yuan. Creditors will definitely suffer losses if greater amounts are involved. In other words, a banking crisis would ensue should more medium- and small-sized banks are found to be “severe credit risks.”
For instance, large banks will have to tighten their interbank lending to medium- and small-sized banks, either through lending less or charging high interest rates. This would in turn lead to tightening liquidity for medium- and small-sized banks and increased credit risks. The fear of this chain reaction could be the main reason why the central bank injected liquidity into the banking system last week.
In fact, the PBoC announced three renminbi reserve requirements ratio cuts (May 15, June 17, July 15; 11 percent down to 8 percent) for over 1,000 rural commercial banks as early as May 15. The RRR cuts will release 300 billion yuan of liquidity into the banking system for the issue of loans to small and micro enterprises.
4. We wrote in our China 2019 outlook that “some financial institutions may go bankrupt,” and the government takeover of Baoshang Bank already verifies our prediction (see the May 28 edition of this newsletter for explanation). Barring unforeseen circumstances, the scale of financial turmoil in China seems to be on track to vastly exceed the scale of our earlier prediction. Financial and economic troubles in China would in turn fulfill our prediction that “a Black Swan event could imperil the CCP regime.”
SinoInsight 3
At a closed-door roundtable organized by the research institute of the Boao Forum for Asia, Japanese think-tank Asia Pacific Initiative, and Caixin on May 27, former PBoC chief Zhou Xiaochuan said, “If you see it (7 yuan per dollar mark) as a (psychological) ‘bottom line,’ that may be a bit of an overreaction.”
On May 29, Yu Yongding, a former PBoC advisor and senior research fellow at the Chinese Academy of Social Sciences, said at a financial forum that while the 7 mark was an important psychological barrier, everyone would eventually adapt when there are constant fluctuations near 7 (7.1, 7.2, 6.9, 6.95) because the numbers “don’t make much of a difference.”
In the month of May, the offshore RMB exchange rate depreciated from 6.7301 to 6.9288, a 2.87 percent decline.
OUR TAKE
The recent remarks by senior Chinese financial officials indicate that the authorities plan to let the yuan fall below 7. This does not contradict recent efforts by the Chinese authorities to curb short selling (Guo Shuqing: “Those who speculate and short the yuan will for sure suffer heavy loss”) and prop up the yuan (PBoC issuing yuan-denominated bills in Hong Kong). The aforementioned efforts appear to be aimed mainly at dissuading short selling and slow down the decrease of foreign exchange reserves.
Per our May 15 article, we hold that the RMB exchange rate could fluctuate between the 7 to 7.5 mark this year.
