1 Threat of US sanctions deters Beijing from expanding support for Russia—for now
US-China relations to stabilize?
June 12
Speaking at the Stimson Center think tank in Washington D.C. , U.S. Deputy Secretary of State Kurt Campbell said that China had to reassure investors and others that it has a plan for the economy and would not seek to create frictions that could escalate in dangerous and unpredictable ways.
Campbell said, “It’s very hard for China to take certain steps without harming its own economy. And I think we now understand that economic performance is central right now to what is important to President Xi.”
Campbell also said, “the hope will be that we’ll be able to settle on certain things that are necessary for the sustainment of the global economy, that are unexceptional with respect to national security.” He added, “Ultimately, that requires both strengthening, extending and also careful coexistence, and that’s really the nature of the diplomatic challenge that we have in front of us. It is one of the most difficult challenges in the history of American foreign policy.”
In responding to a Foreign Affairs article by former Deputy National Security Advisor Matt Pottinger and former chairman of the House Select Committee on the Chinese Communist Party that the goal of U.S. policy should be “a China that is able to chart its own course free from communist dictatorship,” Campbell said that such a goal would be “reckless and likely unproductive.” He added, “I do not believe it is in our interest at the current juncture to add to our list, ‘Let’s try to topple the other leading power on the global stage,’ despite our differences.”
US sanctions Russia and China over Ukraine war
June 12
The U.S. Treasury introduced more than 300 new sanctions against individuals and companies that are said to have supported Russia’s war effort in Ukraine, including entities in China, South Africa, the United Arab Emirates, and Turkey. The Treasury also said it was raising “the risk of secondary sanctions for foreign financial institutions that deal with Russia’s war economy,” a move that threatens to cut those entities from the U.S. financial system.
Separately, the U.S. Commerce Department announced that it was targeting shell companies in Hong Kong for diverting semiconductors to Russia, a move that would affect nearly $100 million of high-priority items for Moscow.
June 13
1. State Department spokesman Matthew Miller said in a regular press briefing that the Biden administration is “considering further actions” against Chinese entities deemed to be supporting Russia’s military industry.
“Our hope is that companies engaged in rearming Russia’s defense industrial base and bolstering Russia’s defense industrial base so it can rearm the Russian military, that other companies will see these actions and think twice,” Miller said. “Countries in Europe have made clear the same thing … and we will not hesitate to take further actions as appropriate.”
2. U.S. Treasury Secretary Janet Yellen told reporters in New York, “I think that the largest financial institutions in China have been trying to comply” with U.S. sanctions against Russia and “have a very strong motive not to be designated” as sanctions violators.
Yellen added, “I’m certainly not going to say that we would not be willing to designate a large bank if we saw systematic violations. The largest banks in China really, really value their correspondent banking relations.”
3. Speaking with President Joe Biden at the G7 summit in Italy, Ukrainian president Volodymyr Zelensky said that Xi Jinping pledged in a phone call not to send weapons to Russia.
“I had a firm conversation with (the) leader of China. He said that he will not sell any weapons to Russia. We’ll see if he’s (a) respectable person he will not, because he gave me (his) word,” Zelensky said.
Biden added, “By the way, China is not supplying weapons but the ability to produce those weapons and the technology available to do it, so it is in fact helping Russia.”
4. Biden and Zelensky signed a 10-year bilateral security agreement at the sidelines of the G7 meeting that would commit future U.S. administrations to support Ukraine. The G7 also agreed to a loan of up to $50 billion to Ukraine backed by profits on frozen Russian assets.
June 14
In a communiqué, the G7 leaders expressed “deep concern” at China’s support to Russia, which allows the latter to maintain its war in Ukraine and “has significant and broad-based security implications.” They urged the PRC to “cease the transfer of dual-use materials” to Russia, including “weapons components and equipment that are inputs for Russia’s defense sector.”
The G7 leaders also expressed concern about the PRC’s “persistent industrial targeting and comprehensive non-market policies and practices that are leading to global spillovers, market distortions and harmful overcapacity in a growing range of sectors.” They further opposed “China’s militarization, and coercive and intimidation activities in the South China Sea.”
US military hints at plans to deter a PLA invasion of Taiwan
June 10
In an interview with The Washington Post, U.S. Indo-Pacific Command head Admiral Samuel Paparo said that the PRC wants to “offer the world a short, sharp war” over Taiwan “so that it is a fait accompli before the world can get their act together.” Paparo believes that Xi Jinping does not want to repeat Russian leader Vladimir Putin’s mistake of allowing the Russian invasion of Ukraine to devolve into a long war of attrition.
China’s likely strategy is to overwhelm Taiwan with a massive attack with little warning, Paparo said. Xi doesn’t want to repeat Russian President Vladimir Putin’s mistake in Ukraine in 2022, when Russia’s full-scale invasion failed to meet its initial aims and devolved into a long war of attrition.
Paparo said the U.S. plan for thwarting Xi’s supposed strategy is called “Hellscape.” The plan would have the U.S. military deploy “thousands of unmanned submarines, unmanned surface ships and aerial drones to flood the area” as soon as the PLA invasion fleet begins moving across the Taiwan Strait, and give Taiwanese, U.S. and partner forces “time to mount a full response.”
Paparo said, “I want to turn the Taiwan Strait into an unmanned hellscape using a number of classified capabilities so that I can make their lives utterly miserable for a month, which buys me the time for the rest of everything.” When asked about the details of “Hellscape,” Paparo said, “I can’t tell you what’s in it. But it’s real and it’s deliverable.”
Our take
1. Deputy Secretary of State Kurt Campbell’s remarks at the Stimson Center about Xi Jinping being focused on the Chinese economy aligns with our multiple earlier assessments that Beijing is not going to invade Taiwan in the short term despite concerns from many observers. The Xi leadership is undoubtedly cognizant of the fact that aggression of any sort during this period will sharply worsen the PRC’s polycrisis and have existential consequences for the CCP regime. We believe that the only scenario where Beijing invades Taiwan before it is prepared and regardless of the many crises plaguing the PRC is if the U.S. and Taiwan act unmistakably to cross the CCP’s “red lines” on Taiwan, including pushing for “Taiwan independence.”
Meanwhile, the CCP is unlikely to be assuaged by Campbell’s comments about the U.S. being disinterested in toppling its regime. The CCP has long seen itself as being locked in a bitter struggle for global hegemony with the “American imperialists,” and that the latter will do whatever it takes to drive it out of power.
2. The recent U.S. sanctions targeting entities that back Russia’s war in Ukraine, Treasury Secretary Janet Yellen’s remark that large PRC financial institutions have strong motivation not to be designated as sanctions violators, and Xi Jinping’s assurance to Volodymyr Zelensky that the PRC will not supply Russia with weapons appear to affirm our analysis of how Beijing will respond to increased Western pressure over Russia. We wrote that the PRC will “continue trying to maintain working diplomatic relations with the U.S. and its allies for as long as possible” and that the Xi leadership will look to “delay and wait for change” before making more committal moves to counter the pressure.
One indirect sign that the threat of U.S. sanctions is having an effect in deterring the PRC from supporting Russia is the drop in China-Russia trade last month. Data from the PRC General Administration of Customs shows a negative 0.8 percent growth in China-Russia imports and exports (in renminbi terms) in May 2024, or the first time the figure had entered negative territory since the Russian-Ukrainian war broke out in early 2022. China’s imports from Russia also plummeted to negative 2.2 percent in May — compared with a monthly average of 14.6 percent in the previous four months — likely because China imported less oil from Russia.
Going forward, Beijing will likely try to have important Chinese entities, and especially the large state banks, toe the line to avoid U.S. sanctions. Smaller entities could also attempt to reduce their support for Russia to escape violating sanctions. Beijing will too likely step up diplomacy to stay in the good books of the U.S. and its allies, and buy the regime more time to resolve its economic and other domestic troubles.
We believe that the U.S. and its allies could yet broaden their sanctions against the PRC regardless of what Beijing does to avoid them if the Russian war effort continues to find success and Ukraine’s situation becomes increasingly dire. The expanding of Western sanctions against China, however, will likely force Beijing to double down in supporting Russia instead of backing off.
2 Falling Mao-tai prices could potentially expand financial risks in China
Kweichow Moutai’s liquor price falls
Prices of Kweichow Moutai’s flagship liquor Flying Fairy have been plummeting since mid-March 2024. Industry data from “Today’s Liquor Price” tracked the drop in the average wholesale price of Flying Fairy to a three-year low in May.
Per bottle in a crate:
- March 22: 2,990 yuan.
- June 13: 2,695 yuan.
- June 14: 2,550 yuan.
Per bottle:
- June 13: 2,420 yuan.
- June 14: 2,230 yuan.
Mainland media reported that while the suggested retail price of Flying Fairy from the distillery was about 1,499 yuan per bottle, the liquor could sell from around 3,000 yuan per bottle on the secondary market. At its peak in 2022, a bottle of Flying Fairy could go for up to 3,800 yuan and there was frenzied speculation nationwide given the profits that could be made. Dongxing Securities analyzed that the annual return on Flying Fairy when prices were high was roughly 10 to 12 percent. However, prices of Flying Fairy have been steadily declining since its peak.
Falling Flying Fairy prices are affecting scalpers and distributors. Distributors receive a fixed annual quota of Kweichow Maotai’s flagship product and are also required to sell other low-profit products from the Moutai distillery. With the current Flying Fairy price more than 200 yuan below the break-even point of 2,500 yuan per bottle, Maotai distributors are facing significant inventory and capital pressures.
Scalpers are also set to incur losses. According to mainland media reports, some major Chinese e-commerce platforms that have been running promotions since May 20 for the “618 E-commerce Shopping Festival” are offering a 400 yuan voucher with every purchase of two bottles of Flying Fairy, but with the condition of delivery after 20 days. This meant that scalpers who purchased Flying Fairy at less than 2,400 yuan per bottle at the start of the e-commerce platform promotion will end up losing money when they finally get to sell their liquor when it is delivered 20 days later.
Kweichow Maotai stocks take a hit
The continuously falling price of Flying Fairy has impacted Kweichow Moutai’s stock price:
- June 11: Kweichow Moutai stock closed down 3.1 percent to 1,569 yuan, or lower than its price (1,577 yuan) when the stock market plummeted (Shanghai Composite Index at 2,635 points) at the beginning of the year. Kweichow Moutai saw more than 60 billion yuan in market value evaporate in a day, dragging down the liquor sector and the broader market.
- June 14: Kweichow Moutai’s stock closed at 1,555 yuan to hit a new low for the year. The stock fell as low as 1,520.46 yuan during intraday training, down 14.5 percent from its peak of 1,777.8 yuan this year. The drop meant that Kweichow Moutai’s stock price had fallen nearly 10 percent since the start of the year and the company’s market value had shrunk from a peak of 2.22 trillion yuan on May 7 to 1.95 trillion yuan (down 270 billion yuan).
Big picture
1. China’s property sector crisis continues to worsen, with sales area and sales volume of real estate continuing to see double-digit declines. According to official PRC data, the sales area of new commercial housing decreased by 20.3 percent year-on-year to 366 million square meters during the January to May 2024 period, while the sales area of residential housing decreased by 23.6 percent to 307 million square meters. Also, the sales value of new commercial housing during the January-May period decreased by 27.9 percent year-on-year to 3.57 trillion yuan, while the sales value of residential housing decreased by 30.5 percent year-on-year to 3.12 trillion yuan.
2. China’s M2 money supply grew by 7 percent from a year ago at the end of May for the lowest growth rate on record. Meanwhile, China’s M1 supply fell by 4.2 percent year-on-year for the largest decline since the data became available.
Our take
1. Mao-tai was once viewed as an infallible investment that would only go up in value (只漲不跌) during the PRC’s boom years. The plunge in the price of Kweichow Moutai’s Flying Fairy in recent months, however, is shattering Mao-tai’s value as an investment and also hints at greater economic decline in China.
The falling price of Mao-tai is a sign of reduced economic and business activity in China. Mao-tai is often served at business dinners and given as gifts; the more real estate projects and government infrastructure projects there were in China, the greater the demand for Mao-tai. Conversely, Mao-tai demand shrinks when there are fewer projects and business activity is low.
Business activity slowed dramatically during the “zero-COVID” years and after the triggering of China Evergrande’s debt crisis in 2021 essentially burst the real estate bubble. Assets in China entered a downward cycle, and luxury goods like high-end cars, watches, and branded bags became difficult to sell. Likewise, the price of Flying Fairy peaked in the second half of 2021 and began to drop after.
Declining Mao-tai prices also reflect the lack of consumer demand in China post-“zero-COVID.” Household incomes were significantly reduced during the pandemic years and did not recover after the PRC’s pandemic lockdown policies were lifted in early 2023. Lower incomes meant that consumers were disinclined to spend on unnecessary items, including on expensive liquor like Mao-tai. Consumers’ unwillingness to splurge on luxury goods and sluggish business activity appeared to have led to the demand for Mao-tai being weaker during the holidays when liquor consumption is higher than during the off-season for liquor consumption.
As demand for Mao-tai trickles off and prices drop even lower, Flying Fairy and other luxury liquor would become increasingly less valuable as an investment. Mao-tai prices are likely to spiral downwards as people scramble to liquidate their stock to cut losses. The situation with Mao-tai is similar to that of China’s property market, where the declining value of houses as an investment has led to falling home prices and decreasing sales, with no end currently in sight.
2. Another factor that could have impacted Mao-tai’s value as an investment asset is the lower than expected growth in China’s money supply. Previously, excess money supply drove investment in luxury liquor and real estate.
China’s money supply is seeing slower growth due to the property sector crisis, which is affecting home sales, land sales, and creating a sharp contraction in housing loans. Central bank data shows that medium- and long-term household loans (mainly mortgages) increased by just 51.4 billion in May 2024, compared to an increase of 442.6 billion yuan in May 2021 (a drop of nearly 90 percent). This means that only 51,400 people applied for a mortgage this May, assuming an average mortgage loan of 1 million yuan per household.
Another factor behind the slower expansion of China’s money supply is funds idling in the financial system and people rushing to buy “risk-free” government bonds. On June 14, the PRC Ministry of Finance issued for the first time 35 billion yuan worth of 50-year ultra-long-term special government bonds, with a coupon rate of only 2.53 percent after competitive bidding. This suggests that institutional investors are having difficulties finding less risky assets with good returns and are opting instead to invest in relatively safe government bonds.
3. Kweichow Moutai’s Flying Fairy losing value as an investment asset is likely to result in new financial risks.
For one, liquor distributors, scalpers, and individuals tend to heavily stock luxury liquor as investment. The “social inventory” held by individuals and entities is conservatively estimated at 50 million to 100 million bottles based on Kweichow Moutai’s sales volume. Assuming a “social inventory” of 75 million bottles, distributors and individual stockpilers could see losses reaching 33 billion yuan after wholesale prices fell by about 440 yuan since March. As the price of Flying Fairy falls below the break-even point of 2,500 yuan per bottle for distributors, distributors could suffer a breakdown in their respective capital chains and various financial risks could be triggered.
Falling prices of Flying Fairy could also impact the prices of other liquor in the industry, affecting the future value of liquor inventories worth billions of yuan. According to the 2023 annual reports of listed liquor firms, the total inventory of the 22 A-share and Hong Kong-listed liquor companies was as high as 155.8 billion yuan at the end of 2023, with Kweichow Moutai alone accounting for over 46.4 billion yuan of the total.
Further, the declining fortunes of Kweichow Moutai will affect many investment funds since the company’s stock is a major holding. A report from Shanghai Securities News in April 2024 noted that Kweichow Moutai is the top holding of funds for eight consecutive quarters since the second quarter of 2022. Shanghai Securities News added that Kweichow Moutai’s stock comprised nearly 80 percent of the holdings of investment funds on average at the end of the first quarter of 2024, with open-ended funds focused on equities having Kweichow Moutai’s stock comprise nearly 90 percent of their holding on average. Aside from Kweichow Moutai, the top 50 major funds also hold stocks of other major liquor companies like Wuliangye, Luzuo Laojiao, Shanxi Fenjiu, Gujing Gongjiu, and Jinshi Yuan.
A significant drop in Kweichow Moutai’s stock price would see numerous funds lose market value. Financial risks in the PRC will steadily accumulate as prices of luxury liquor and the stock value of liquor companies continue to fall.
