SinoInsight 1
On July 22, the United States ordered the People’s Republic of China to close its consulate in Houston. The U.S. Department of State said that the consulate was directing “massive illegal spying and influence operations.” David R. Stilwell, the Assistant Secretary of State for the Bureau of East Asian and Pacific Affairs, told The New York Times that the Houston consulate had a “had a history of engaging in ‘subversive behavior’ and was the epicenter of research theft in the United States.”
The Times cited a document compiled by U.S. law enforcement on FBI investigations linked to the Houston consulate that included “attempts to illegally transfer medical research and other sensitive information from institutions in the area; talent recruitment plans to persuade more than 50 researchers, professors and academics in the area to turn over tightly held research or information to Chinese institutions; and the coercion of Chinese citizens in the United States whom the Chinese government has deemed as wanted fugitives to return to their homeland.”
On the same day, Axios reported that the PRC’s San Francisco consulate was harboring a PLA military researcher wanted by the FBI. Richard Grenell, the former Acting Director of National Intelligence, told Reuters that the U.S. could close the San Francisco consulate. President Donald Trump also said during a Q&A session at a news briefing that it was “always possible” other PRC missions could be closed.
PRC foreign ministry spokesman Wang Wenbin warned that the PRC would “resolutely respond” to further closures. According to various news reports, the CCP is considering closing the U.S. Consulates General in Wuhan and Hong Kong.
The U.S. closure of the PRC’s Houston consulate prompted several mainstream media outlets to declare a “Cold War” between America and China.
OUR TAKE
1. We wrote in the May 21 edition of this newsletter that the Trump administration has “lost patience with the CCP regime” and “the Sino-U.S. rivalry could see a steep escalation in the near future.” The closure of the PRC’s Houston consulate affirms our earlier analysis. We will not be surprised if the Trump administration orders other PRC consulates to close shop.
With the consulate closure, the Trump administration is sending a clear signal to the American people, Wall Street, and big businesses, as well as U.S. allies, partner nations, and countries in the Indo-Pacific region, that America is committed and serious about standing up to the CCP regime over its malign behavior. Countries and businesses can either choose to side with the U.S. against the CCP threat, or continue working with the CCP and face punitive measures as the Trump administration gets tough on China.
U.S. allies are gradually aligning themselves with America on the CCP issue. The United Kingdom recently banned Huawei 5G from its networks, and France imposed limits on Huawei 5G equipment that effectively ban Huawei by 2028.
2. The CCP cannot do much to retaliate effectively against the U.S. over the closure of the Houston consulate. Closing the U.S. consulates in Wuhan and Hong Kong would definitely inconvenience America, but would almost certainly give grounds for the Trump administration to close additional PRC consulates in the U.S. and mete out even harsher punishment against the CCP.
The CCP has thus far flirted with the nationalism card in reframing news of the closure of the Houston consulate. PRC foreign ministry spokesman Wang Wenbin accused the U.S. government, without providing evidence, of “shifting the blame to China with stigmatization and unwarranted attacks against China’s social system, harassing Chinese diplomatic and consular staff in the US, intimidating and interrogating Chinese students and seizing their personal electronic devices, even detaining them without cause.” Hua Chunying, a PRC foreign ministry spokeswoman, tweeted that the PRC Houston consulate received “bomb and death threats” due to “smears and hatred” by the U.S. government, or in other words implying the PRC “actually” closed the consulate of its own volition over safety fears rather than being shut down by the U.S. for the PRC’s illegal operations. The CCP will likely play the nationalism card judiciously as it attempts to deceive the Chinese people on the Houston consulate closure. However, this nationalism play is a double-edged sword; the CCP still needs diplomatic relations with the United States, but it will not be able to justify maintaining relations when the Chinese people get riled up and overzealous.
The CCP will also likely face increased financial pressures over the closure of the Houston consulate and America’s toughening stance on China. The geopolitical reality of a Sino-U.S. “new cold war” will force foreign investors to re-evaluate their position in Hong Kong and mainland China. The renminbi will come under pressure as investments flow out of China, and the PRC’s deteriorating financial situation will lead to escalations in the factional struggle within the CCP elite. Intensifying factional struggles will precipitate political risks for foreign investors and businesses in China, which will then foment more capital outflows.
3. We have been warning about worsening Sino-U.S. relations and a “new cold war” since 2018. Recent remarks and actions by the Trump administration show the “new cold war” is an undeniable reality:
- On June 24, White House National Security Advisor Robert O’Brien delivered a speech titled, “The Chinese Communist Party’s Ideology and Global Ambitions.”
- On July 7, FBI Director Christopher Wray delivered a speech titled, “The Threat Posed by the Chinese Government and the Chinese Communist Party to the Economic and National Security of the United States.”
- On July 14, President Trump signed an executive order on “Hong Kong Normalization” ending the U.S. special exemptions for Hong Kong. The Trump administration’s choice of the term “normalization” is almost certainly a nod to the Cold War and the Soviet Union’s “normalization” (i.e. re-establishment of Soviet control) of wayward Eastern bloc countries like Czechoslovakia in 1968. In other words, the Trump administration is recognizing a de facto communist takeover of Hong Kong with the CCP passing a national security law over the territory.
- On July 16, U.S. Attorney General William Barr delivered a China policy speech where he spotlighted American companies’ “corporate appeasement” to the CCP and warned that they would face repercussions if they continue to align themselves with the Chinese communist regime.
- On July 23, U.S. Secretary of State Mike Pompeo will deliver a speech on “Communist China and the future of the free world” at the Richard Nixon Presidential Library in Yorba Linda, California.
The U.S. closure of the PRC Houston consulate is perhaps the most tangible indication thus far of “cold war” relations between the two sides.
4. We noted in our 2020 mid-term review that the CCP is “beset with a ‘perfect storm’ of problems that are creating conditions which could result in regime collapse.” We believe the closure of the Houston consulate is the latest development accelerating the CCP towards a “Berlin Wall” moment. Another development to watch is the Trump administration’s willingness to admonish the CCP over human rights and religious freedom issues, including highlighting once sensitive and “taboo” topics like the persecution of Falun Gong.
Businesses, investors, and governments must account for rapidly rising political risk levels in the PRC and prepare contingencies for a post-communist China.
SinoInsight 2
Foreign capital flowing into renminbi-denominated PRC government bonds in the second quarter of 2020 surpassed 4.3 trillion yuan ($619 billion), or the fastest pace since late 2018 according to economic data provider CEIC per a July 13 report in The Wall Street Journal. In reporting the news, PRC propaganda outlets upheld the data as “evidence” that foreign capital is not withdrawing from China.
OUR TAKE
1. China’s economy seems to be recovering in the second quarter per the CCP’s own economic data and various economic indicators like rising foreign investments, currency appreciation, and a “bull market.” Rapidly deteriorating Sino-U.S. relations and the looming threat of a second wave of infectious diseases, however, mean that China’s current “prosperity” is illusory and the mainland is definitely not a financial “safe haven.”
2. The CCP managed to attract hot money from abroad in June due to the perception that China has performed well in handling the coronavirus, a stronger RMB exchange rate, and a “bull market,” among other reasons. The influx of hot money, however, comes on the back of substantially reduced Chinese exports and the CCP facing a “new cold war” with the United States. The Sino-U.S. “new cold war” will make China unattractive for foreign investors as the Trump administration hits the CCP with more punitive measures in the coming weeks and months. The Sino-U.S. tech war likewise makes it more onerous for the CCP to keep speculative capital in China; Chinese technological innovation will be acutely stymied given the authoritarian nature of the CCP and U.S. bans on Chinese tech companies.
The inflow of speculative capital is not necessarily fortuitous for the CCP regime at this time. Hot money will inflate asset prices and the RMB exchange rate, further affecting exports at a crucial time. The rapid accumulation of speculative capital will also rapidly grow China’s foreign debt, which currently stands at over two-thirds (over $2 trillion) of China’s foreign exchange reserves. Hot money will vacate China once investors see sluggish returns, and quick outflows will pressure the RMB exchange rate and China’s foreign reserves.
3. The CCP’s policies meant to rescue the worsening Chinese economy thus far have had a limited impact due to structural problems with the authoritarian system.
Recent data from the PRC’s National Bureau of Statistics indicates that the Chinese economy is experiencing stagflation. Consumer prices in June rose by 2.5 percent year-on-year, while factory prices for industrial products fell by 3 percent over the same period. The difference between consumer and factory prices for industrial products rose as high as 5 percent. Without technological innovation to drive the economy and build on momentum of speculative investments, the CCP cannot resolve the stagflation problem.
Meanwhile, the CCP’s usual stimulus measures appear to have failed to spur growth. In the first half of 2020, China’s investments in fixed assets fell by 5.8 percent, investments in secondary industry dropped by 15 percent, and investments in property development shrunk by 1.9 percent. Private investment, which accounts of 56.1 percent of total investments, also decreased by 12.4 percent. Decreasing investments in China signify businesses and investors are pessimistic with regards to the Chinese economy.
4. Other official data indicates that China’s economy has not yet recovered to pre-coronavirus conditions. For instance, passenger traffic volume in June was 801 million people, down 43.7 percent from a year ago. This means that fewer migrant workers are returning to cities for work, meaning there is decreased commercial activity. Decreased commercial activity and more unemployed decreases consumption.
