Sunday, 29 November 2020


Companies cut reliance on China post-Covid

Westpac Institutional Bank chief Anthony Miller: ‘A lot of businesses took actions to stabilise their operations out of urgent necessity, but in the process, many have brought in changes that promise future benefit.’ Picture: James Croucher
Westpac Institutional Bank chief Anthony Miller: ‘A lot of businesses took actions to stabilise their operations out of urgent necessity, but in the process, many have brought in changes that promise future benefit.’ Picture: James Croucher

A large majority of firms across the Asia-Pacific region are actively looking to reduce their supply-chain reliance on China, a Westpac report has found.

The latest Asia-Pacific CEO survey conducted by the bank’s institutional arm found a number of large corporations in the region had or are planning to bring manufacturing back to domestic operations in order to minimise sourcing risks.

Surveying 113 chief executives, the report found two-thirds of firms experienced significant supply disruptions during the coronavirus pandemic, and more than half have decided to manufacture onshore.

“Over half (57 per cent) of firms in the survey have begun to onshore supply and/or manufacturing, in order to secure their supply, and more (63 per cent) expect to continue in this direction in the future,” the Westpac survey said.

“Many CEOs are likely to see such measures as helping to reduce supply dependence on China.”

The reduction in supply risk coincides with a dramatic ­breakdown in trade relations between Australia and China, which has hit major exporters within sectors such as agriculture and resources.

Last Friday the souring relationship lurched into the spotlight again when Chinese authorities slapped Australian winemakers with import tariffs of up to 200 per cent.

The Chinese government claims Australian winemakers have been illegally dumping wine into the Chinese market, lowering prices.

The fallout has already had a material impact on Australia’s largest wine producer, Treasury Wine Estates, which on Friday saw its share price tumble by about 11.25 per cent to $9.25 before the ­company went into a trading halt.

Westpac executive Anthony Miller said the increasing shift to onshore manufacturing presented an opportunity to “reinvigorate” the economy’s domestic manufacturing sector.

“We’re going to see a focus on smart manufacturing, which will create jobs — particularly high skilled opportunities — and it’s going to see us build capability in areas where we can be very competitive on an international scale.”

The Westpac report also highlighted that a number of firms remained resilient during the pandemic and were able to adapt to changing demand and operating conditions.

According to the survey, 69 per cent of CEOs said they had become more resilient as a leader, while 72 per cent of respondents said organisational decision-making had become quicker.

Mr Miller noted prompt responses by senior management had accelerated digitisation strategies, particularly in the realm of technology designed for coping with a remote workforce.

“A lot of businesses took actions to stabilise their operations out of urgent necessity, but in the process, many have brought in changes that promise future benefits — some unanticipated — in terms of efficiency and team cohesion,” Mr Miller said.

Westpac’s report surveyed chief executives from 113 companies located in Australia, China, Japan, Singapore, Indonesia and New Zealand.

The survey was conducted in July and August.

Saturday, 28 November 2020


Stocks Say Covid Recovery Is Nigh. Bonds Tell a Different Story.

All-important Treasury market is a holdout in reflecting increased economic optimism from Covid-19 vaccine news

The message from vaccine news is clear: Things are looking better. But the Treasury market seems to have missed the memo. PHOTO: SPENCER PLATT/GETTY IMAGES
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After the Covid-19 vaccines proved effective this month, almost every corner of the market signaled that a faster recovery is on the way. Economically sensitive stocks, industrial metals, crude oil, the flakiest junk bonds: all have rallied hard. But not Treasurys.

The vast U.S. government bond market is usually highly sensitized to growth prospects, and especially to what’s known as the “reflation trade”: The bet that the economy will rebound quickly. Faster growth almost always means higher inflation, higher yields and so lower Treasury prices.

This time, the bet has changed, with investors starting to accept that the reflation trade won’t bring, you know, actual inflation.

The prospect of vaccines returning life to normal injected wild hope into many of the least-popular assets. Oil major Exxon Mobil is up 23% so far in November, putting it on track for its best month since at least 1972, the year Standard Oil Company of New Jersey renamed itself. The Russell 2000 index of small stocks, up 21%, is heading for its best month since at least 1988.

The lockdown losers hit the worst this year are doing incredibly well this month, with nine S&P 500 stocks up more than 50%. Boeing, cruise lines Carnival and Royal Caribbean, several airlines, mall owners, hotels and entertainment stocks, and Citigroup are up more than a third. The Vix gauge of implied volatility has plunged from a pre-election high of 41 to flirt with the summer lows just above 20.


Junk bonds rated as close to default, or triple-C, have returned 7.3% so far in November, on track for their best month since the panic about shale oil in 2016. Investors are accepting extraordinarily low yields, below 6% for some of them, including those from online taxi firm Uber Technologies, and a handful are below 5%, according to ICE Data Services.

Cyclical stocks sensitive to the economy have done very well, while defensive stocks able to ride out recessions are in less demand. In particular, some of the stocks that won as we stockpiled groceries and worked from home have lagged behind badly this month: disinfectant company Clorox, gold-miner Newmont and Spam maker Hormel Foods are all down, even as the market is up. The haven of gold has fallen, too.

The message is clear: things are looking better. But the Treasury market seems to have missed the memo. Yields leapt on the day of the Pfizer vaccine, but have since fallen back, with the 30-year yield—usually supersensitive to growth prospects—lower than at the start of the month, along with the 10-year.

This unusual divergence isn’t because the bond whisperers think the vaccine doesn’t matter. It is about the Federal Reserve and inflation, or rather the lack of it. After a decade when faster growth, low unemployment and zero interest rates did nothing to spark inflation, many no longer expect even extraordinary Fed action to push up prices faster.


What signals are Treasury bonds sending about the Covid-19 economic recovery? Join the conversation below.

“The [vaccine] surprise is on the growth side, not the inflation side,” says John Roe, head of multiasset funds at Legal & General Investment Management. “Even at very low levels of unemployment the Fed struggled to generate any wage inflation, and now there is quite a lot of slack in the labor market.”

Inflation prospects have barely budged, despite the boost to the economy a vaccine is expected to bring. The implied inflation rate calculated by comparing yields on Treasurys and on Treasury inflation-protected securities for the five years starting in five years’ time has risen only to 1.83% from 1.81% at the end of October, still below the 1.92% reached last month, the highest since August last year.

With inflation off the agenda, investors think the Fed will stamp down hard on any rise in yields, because of the drag on growth from higher borrowing costs. “The Fed just overwhelms everything,” says Rick Rieder, chief investment officer of global fixed income at BlackRock.

The election could still be having an effect, too. Investors had prepped for a Democratic sweep of Congress, but—barring an unlikely double Democratic win in Georgia’s runoff votes—Republicans will control the Senate. Investors think that means much lower fiscal stimulus, and so more monetary stimulus, probably in the form of yet more buying of long-dated bonds. Traders unwinding their previous bets against bonds and readying for more Fed buying keeps yields down.

“With the outlook for aggressive fiscal policy less likely, that keeps the Fed in the game,” says Johannes Mueller, head of CIO office and macro research at German fund manager DWS.

Inflation-free growth would be good not only for investors but for everyone, as it allows interest rates to stay low even as the economy accelerates. But there are a couple of reasons for caution, as Treasurys and everything else could come back in line. First, if the market sniffs any hint of price rises, there could be an explosive rise in bond yields that hurts stocks and other assets as investors return to their normal inflation expectations.

Second, this month’s huge gains by economically sensitive assets assumes a quick vaccine approval and deployment. If the massive logistical challenge takes longer than hoped it would leave investors free to focus on the economic damage from a rapidly worsening third wave of coronavirus in the U.S. This month’s big winners could be hit hard by bad news.


HSBC considers exit from US retail banking

Branch of HSBC in Washington DC, US, in June
A retreat from US retail operations would mark the end of HSBC’s 40-year long attempt to run a full-service, universal bank in the country  © AFP via Getty Images

HSBC is weighing up a complete exit from retail banking in the US after narrowing the options for how to improve performance at its struggling North America business, according to two people familiar with the situation.

Senior management aim to present the plan to the bank’s board in the coming weeks, the people said, as HSBC seeks to allocate resources away from the US in favour of more profitable businesses in Asia.

Closure of the US retail network would mark the end of the lender’s 40-year long attempt to run a full-service, universal bank in the country. The division made a pre-tax loss of $518m in the first three quarters of this year, following losses of $279m last year and $182m in 2018.

HSBC’s American division has been under intense scrutiny for several months as part of the UK lender’s efforts to make even deeper savings than it pledged in February, when it outlined $4.5bn in cost savings and 35,000 job cuts. 

Executives decided the impact of the coronavirus crisis and a prolonged period of ultra-low interest rates required more drastic measures, the Financial Times reported in May.

A full exit from the US is no longer on the table, according to the two people. “The US is an important marketplace,” one said, particularly for HSBC’s investment bank. It is also seeking to grow its US wealth management division.

Managers are likely to also recommend trimming HSBC’s investment bank client roster to focus on international clients, particularly those with Asian and Middle Eastern links, the people said.

Those with only domestic US business, which are less profitable and where HSBC struggles to find an edge against larger Wall Street rivals like JPMorgan and Citigroup, will be de-emphasised. The bank said in the third quarter it had already eliminated $4bn of risk-weighted assets in its US business through “client optimisation”.

Following the closure of 80 branches this year, HSBC has around 150 branches on the east and west coast of America, a fraction of the branch network of JPMorgan and Bank of America.

Some insiders argued that the division’s lack of scale makes it hard to turn round, especially in the current economic environment.

Against this backdrop, there is a strong case for completely leaving retail banking, according to one person familiar with the situation. Another option is to adopt a digital-only model focused on international clients from the Chinese or Indian diaspora, although that is a “crowded market”, the person added.

The biggest US banks have been investing heavily in their digital offerings, where online-only players including BBVA’s Simple and Goldman Sachs’ Marcus compete with European fintechs like N26 and Monzo, which launched in the US last year.

HSBC has not made a final decision on the future of its US retail business. “The jury is still out . . . we are examining the financial viability of the cost and the reward of exiting or having a middle strategy where we keep a smaller presence,” one of the people said. The timeframe for a decision could slip to next year. HSBC declined to comment.

At the bank’s third-quarter results last month, HSBC chief executive Noel Quinn pledged to go “further and faster on our cost and risk-weighted asset reduction programmes”, after setting aside $7.7bn for potential loan losses during the pandemic. The lender’s share price is down almost a third this year.

HSBC first entered the US consumer market in the 1980s. A disastrous acquisition of subprime mortgage lender Household International in 2003 caused the bank billions in losses and resulted in misconduct penalties after the financial crisis. It sold off half its branch network and a profitable $30bn credit card business in 2011.

Since then, successive executives have debated how best to restore the US retail operation to sustainable profitability, without much success. It lacks high-margin earnings from unsecured credit card lending, and the subscale wealth and branch network have rarely made money. 


House Will Vote on Bill Restricting Chinese Firms Listed in U.S.

  • Similar measure on Chinese listings passed Senate in May
  • White House and SEC are also targeting Chinese companies

The House is set to vote on bipartisan legislation that would impose restrictions on Chinese companies listed on U.S. exchanges, including requiring certification that they’re not under control of a foreign government.

The bill’s sponsors say the aim is to ensure foreign companies traded in America are subject to the same independent audit requirements that apply to U.S. firms. In doing so, the measure threatens to boot Chinese companies, including behemoths like Alibaba Group Holding Ltd. and Baidu Inc., out of American stock markets.

The Holding Foreign Companies Accountable Act (S. 945) will be considered Wednesday under a streamlined process that limits debate on the House floor, allows no amendments, and requires approval by two-thirds of members present and voting to pass.

The Republican-led Senate passed the measure in May; scheduling a House vote now, under an accelerated process typically used for non-controversial matters, signals conditional bipartisan support.

“The current policy that allows Chinese firms to flout the rules that American companies follow is toxic,” Senator John Kennedy, a Louisiana Republican, said in a statement to Bloomberg News on Saturday. Kennedy introduced the bill with Senator Chris Van Hollen, a Democrat from Maryland.

At issue is China’s refusal to let inspectors from the Public Company Accounting Oversight Board review audits of Chinese companies that trade on U.S. exchanges. It’s gained urgency due to rising tensions between the two countries on several fronts, from military to human rights, and also follows this year’s high-profile accounting scandal at Luckin Coffee Inc.

“It puts American families and workers at risk by jeopardizing their college and retirement savings,” Kennedy said. “My colleagues on both sides of the aisle recognize that fact and that we have a solution at hand.”

The legislation holds that if a company can’t show it’s not under the control of a foreign government, or the PCAOB isn’t able to audit the firm for three consecutive years, the company’s securities would be banned from U.S. exchanges.

The planned House vote comes as the U.S. Securities and Exchange Commission has been working on potential parallel regulatory action that could lead to a delisting of Chinese and other certain foreign companies for not complying with U.S. auditing rules, Bloomberg News reported this month.

The battles over audit inspections date back almost 20 years, to the 2002 Sarbanes-Oxley Act which overhauled regulation of public company audits after the collapses of Enron Corp. and WorldCom Inc. The law set up the PCAOB and required it to conduct regular reviews of companies’ books. Though it applies to businesses across the world if they tap the U.S. markets -- and more than 50 foreign jurisdictions permit the reviews -- China has refused to comply.

U.S. and Chinese officials have repeatedly failed to come up with a compromise. In the meantime, Chinese companies have continued to go public on U.S. stock exchanges. They’ve raised about $12 billion in IPOs this year.

Chinese stock listings have also attracted President Donald Trump’s attention. This month, he signed an order barring U.S. investments in Chinese firms owned or controlled by the military, a move that could affect 31 companies and potentially more before Trump exits the White House.


Apple Suppliers’ Exodus From China Won’t Slow Down Under Biden

  • Foxconn eyes Vietnam for some production of iPads and MacBooks
  • Pegatron is in the process of readying an iPhone site in India

The splintering of the global tech supply chain that began during President Donald Trump’s watch looks set to persist under his successor.

Apple Inc., the largest of the many tech giants that rely on Chinese factories to make their gadgets, will move some production of its iPads and MacBooks to Vietnam. Key assembly partner Hon Hai Precision Industry Co., known also as Foxconn, has allocated $270 million in new investments to the Southeast Asian country. Those moves presage a larger and longer-term migration that may have ramifications for the iPhone maker as well as China’s role as workshop to the world.

Foxconn founder Terry Gou coined the term “G2” to describe the trend of a unified supply chain splitting into at least two. Company Chairman Young Liu said in August that the likes of India, Southeast Asia and the Americas could each in the future end up with a dedicated manufacturing ecosystem of their own. The trend now looks irreversible as other countries including India and Vietnam are boosting their infrastructure and efforts to lure manufacturers through lower costs and fewer geopolitical worries.

Inside the Most Ambitious Push Yet to Make iPhones Outside China
Employees test mobile phones at Rising Stars Mobile India Pvt., a unit of Foxconn Technology Co., in Sriperumbudur in India last year. Photographer: Karen Dias/Bloomberg

“As China gets more expensive, and as U.S. politics have been unpredictable, companies have shifted production of some goods out of China. That trend will continue as China gets more expensive and as Vietnam and India improve their competitiveness,” said Dan Wang, a technology analyst at Gavekal Dragonomics.

Trump’s trade hostilities against China caused many manufacturers to shift production capacity to neighboring countries like Vietnam and further afield to sites in Mexico and India, in order to avoid being slapped with punitive tariffs and to mitigate future sanctions risk. Apple, whose Chief Executive Officer Tim Cook orchestrated the creation of its current Chinese-centric production chain, has resisted a large-scale move but in recent years has increasingly explored alternatives.

The Cupertino, California-based company is continuing to add iPhone capacity in India through its assembly partners, aided by Prime Minister Narendra Modi’s policy to attract top-tier smartphone companies to make their gadgets locally for export. Pegatron Corp., the last of the major iPhone assemblers to arrive in the country, announced earlier this month it is injecting 11 billion rupees ($150 million) into its Indian unit and will start production there as soon as late 2021.

Back at home, the iPhone maker has been lobbying the U.S. government to support local chip production with tax breaks. Its key supplier Taiwan Semiconductor Manufacturing Co. is planning a chip fab in Arizona, though the modest scale and technology of that facility would suggest it will service smaller customers, at least to begin with.

Beyond Apple, Alphabet Inc.’s Google has placed orders with Foxconn to assemble key components for its servers in Wisconsin, at the under-utilized facility that has to date been most famous for what it hasn’t produced. Mass production there is expected to go ahead in the first quarter. Pegatron officials said earlier this month that the company plans to also set up manufacturing operations in the U.S. to serve other customers.

Release of the Apple iPhone 12 Pro Max and Mini Models in Stores
Customers at iPhone 12 launch event in Sydney this month. Photographer: Brendon Thorne/Bloomberg

Wistron Corp., another Taiwanese contract manufacturer that handles iPhone orders as well as laptop and server production for other American customers, announced plans earlier this month to add capacity in Mexico and Taiwan. It’s also buying a Western Digital Corp. factory in Malaysia. Chairman Simon Lin said in March that half of Wistron’s capacity can be located outside of China as soon as 2021, with Vietnam operations ramping up and the company seeing India as a key strategic site for the next decade due to its market size and resources.

Trump’s tariffs on Chinese-made products have also forced other international companies to rethink their manufacturing operations. Nintendo Co. now has some of its Switch console production handled by Sharp Corp. in Malaysia, after it asked its main assembly partner Foxconn Technology Co. to offer geographic alternatives to its core China operations. Foxconn Tech, a major entity of the Foxconn Technology Group and a Sharp shareholder, made the connection between the two Japanese firms.

While Apple is diversifying its global supply chain, it’s also deepening its links with local Chinese manufacturers to serve the domestic market. Earlier this year, China’s Luxshare Precision Industry Co. struck a deal to acquire Wistron’s iPhone production facilities in the country, a move that will create the first mainland company to assemble Apple’s marquee handsets. Compatriot BYD Electronic International Co. is also now splitting iPad orders with Foxconn and Compal Electronics Inc., a person familiar with the matter said. AirPods orders, meanwhile, are now dominated by Luxshare and another compatriot, GoerTek Inc.

It took Foxconn 30 years to build up its massive Chinese operations and India or any other region is unlikely to catch up overnight, Foxconn’s Liu said earlier this month.

The supply chain shift will take time, “and China will remain a major electronics manufacturing hub for at least the next five years,” Gavekal’s Wang added.



Joe Biden says America is back. Back to what?

President-elect Joe Biden on Nov. 25.
President-elect Joe Biden on Nov. 25. (Demetrius Freeman/The Washington Post)
November 28, 2020 at 5:26 a.m. GMT+8

“America is back,” said President-elect Joe Biden as he announced key members of his foreign policy team. Those three seemingly simple words in fact require a lot of unpacking: back to what?

Trump-era foreign policy has certainly been a departure from seven decades of bipartisan consensus among leaders in government, business and philanthropy. The generation that felt itself dragged into two catastrophic world wars concluded that only the United States had the economic and military muscle to establish and maintain a more stable order. They understood that the long-term interests of Americans were best served by the gradual expansion of peace and prosperity worldwide.

This stance toward the world has always bred suspicion and resentment among those who, like President Trump, tend to believe that every transaction necessarily involves either “winning” or “losing.” By their logic, the wealth of other nations must reflect, at some level, a “loss” for the United States, because the money is in their pockets, not ours. Taken to an appalling extreme, Trump anathematized NATO as some sort of bad deal for our country. “The one that benefits, really, the least is the United States,” he said last year, adding: “We’re helping Europe.” In fact, the unprecedentedly stable Western alliance has been indispensable to U.S. power and wealth for Trump’s entire lifetime.

As former chair of the Senate Foreign Relations Committee, Biden is deeply steeped in the traditional win-win view of America’s role in the world, and his team reflects that conviction. The United States, in his view, can never have too many friends, and the success of our friends is good for us, too. He is like the homeowner who understands that a safe neighborhood raises everyone’s home values.

To the extent that Biden takes the country “back” to the expansive, internationalist approach, he will benefit the national interest. But it would be a mistake to turn the clock “back” to 2016. Post-Cold War foreign policy was off track in some important ways. Trump’s radical reboot has positioned Biden to start from a new place and build something better.

Start with China. In hindsight, it’s clear that the United States gave too much and demanded too little in facilitating Beijing’s economic rise. The bipartisan consensus took as an article of faith the idea that prosperity and freedom would go hand in hand. Instead, the ruling Communist Party has grown richer — and more repressive, too. From Uighur concentration camps in Western China to the crackdown on Hong Kong in the east, Beijing is proposing an alternative to the human-rights-oriented American order. And China’s escalating conflict with Australia, a stalwart U.S. ally, is a head-on challenge to our influence across the Pacific rim.

The Biden administration should maintain Trump’s insistence that China fulfill its responsibilities and play by the rules — but do it smarter. That means restarting the Trans-Pacific Partnership of enhanced trade with our many friends in China’s neighborhood. We won’t be pushed by a repressive communist regime into abandoning longtime partners or surrendering zones of influence.

In the Middle East, Trump recognized the opportunities presented by the United States’ rise to energy independence. No longer hamstrung by our addiction to Arab oil, the United States has begun to rethink the possibilities in this seemingly impossible region. The recognition of Israel by the United Arab Emirates and Bahrain reflects a sober understanding that endless conflict stands in the way of urgently needed economic diversification across North Africa.

Team Biden should press ahead with this breakthrough rather than go back. In doing so, however, the new administration should end the mollycoddling of Saudi Arabia’s reckless Crown Prince Mohammed bin Salman. Modernization, yes; wars and assassinations, no. That’s not too much for the West to ask of MBS. As to Iran, Biden should take a long, reflective pause before undoing Trump’s policy — not because Trump was careful about withdrawing from the Iran nuclear deal (he was rash), but because U.S. interests are damaged by a ping-ponging partisan approach to such a delicate matter of long-term importance.

Finally, Biden should not go “back” on Trump’s engagement with our nearest neighbors. Having renegotiated the North American Free Trade Agreement, the current administration leaves the country pointed toward shared prosperity. The goal should be to extend this development all the way to Tierra del Fuego, knitting the Americas into a hemisphere of happiness. No wall can stem mass migrations to the United States, but give people good jobs in peaceful communities and most will prefer to stay home.

Resolute regarding China, flexible in the Middle East, bullish on development of the Americas: These three themes constitute the best of Trump’s unconventional, sometimes dangerous, foreign policy. As Biden restores the United States to its rightful place in the world order — the friend of freedom and the scourge of tyrants — on these fronts, he should push ahead.

Friday, 27 November 2020


Ticking time bomb: why Xi is dragging down the dragon

In the midst of global pandemic gloom, Australia’s exporters were at first cheered by a glimmer of hope — China’s economic bounceback. But those hopes were swiftly dashed. China’s rulers no longer seem to want its citizens to buy our products.

And since the US election, a further worry: Joe Biden might make nice with counterpart Xi ­Jinping, leaving Canberra isolated in its concerns about Beijing’s aggressive behaviour, and American exporters will steal our Chinese markets. Online jokers are already anticipating Beijing’s great imperial palace being rebranded the For-Biden City.

This chain of angst about China underlines the disruptive success of Beijing’s wolf-warrior strategy. But beneath it all, an even more momentous time bomb is ticking away.

What if China’s recovery — which is being driven substantially by Western stimulus funding that has boosted demand for its tech gadgets and health gear — slowly slides downhill over the next few years? What if China’s economy starts to lose its mojo?

This has become almost unthinkable. All the more important, then, to consider it.

The Australian budget for 2021 is predicated on China’s economy growing by 8 per cent, and then going on, the Treasury hopes, to “strengthen further”.

Australia’s defence planning has become preoccupied with anxiety about the apparently inevitable day when China’s economy leaps over America’s.

Leading strategic thinker Hugh White says in his latest book that “China will challenge America’s position at the forefront of key emerging technologies”, with its economic rise “transforming its ambitions as an international player”.

ANZ chief economist Richard Yetsenga says the circumstances are changing, however, and that it will now be “very difficult for China to become the world’s largest economy (in market-economy terms) by 2030 — even reaching that milestone by 2050 seems ­ambitious”. The US average income per person today is 3.3 times or 6.4 times China’s, depending on the measure.

Bian Lichun, founder of the Liucundao Business School, teaches a home organising class in Beijing.
Bian Lichun, founder of the Liucundao Business School, teaches a home organising class in Beijing.

Meanwhile, Australians are becoming habituated — or resigned — to a commercially coercive Chinese state constricting their capacity to deliver some of the products and services, from barley to wine, cotton to tourism, for which Chinese firms and people had demonstrated an increasingly healthy appetite.

China’s economy grew by 4.9 per cent in the past quarter, its overworked steel mills sucking in vast shipments of iron ore from the Pilbara, so far unaffected by those bans on what Beijing views as more niche products.

Yet ratings agency Moody’s says that despite some bounce-back, overall in this COVID-19 era “China’s growth will significantly slow across the board this year”. And if China’s economy continues to slide over the next few years ­towards the global mean, as Yetsenga expects, Beijing’s capacity to continue weaponising its economic heft in order to expand its ­influence around the world will become steadily eroded.

China’s leader Xi Jinping might thus need to push more rapidly towards his goals of “the great rejuvenation of the Chinese nation” and of global leadership, while he still has waves of capital to deploy — or to threaten to withhold. In Beijing’s own terms, Xi has won two signal victories this year: as the People’s Leader of the People’s War with COVID-19, against which the capitalist West continues to struggle; and by following up his subjugation of Tibet and Xinjiang by also bringing Hong Kong to heel through imposing the new National Security Law, leaving only Taiwan untamed among China’s borderlands.

But his great new challenge is to be fought on territory in which Xi feels less comfortable — reconstructing China’s economy. For China’s economic ascendancy matters considerably more than its military might.

It is essential for Beijing that while political, diplomatic and ­security issues may rage to and fro, people at home and abroad remain convinced that China’s economy will continue to thrive as the threat of COVID-19 recedes there, driving world growth — including Australian growth — once more, as it did during the Asian and global financial crises.

But despite the recent sprouting of positive numbers, that’s unlikely to happen in the same way this time. First, because China’s economy is heading for some trouble internally. Second, because its global engagement as “the world’s factory” — while flourishing thanks to COVID-era demand, especially for tech gadgets and medical equipment — will start to flag.

Third, because the politics is getting in the way of good policy, both inside China and, to an extent, outside. Beijing’s economic sanctions, and threats of them, against Australia and other countries act like wrenches slung into the cogs of machines that make for mutually beneficial trade.

The new 15-nation Regional Comprehensive Economic Partnership that includes China and Australia but not the US or India — the latter withdrew — will smooth some trade processes but can’t guarantee that Beijing truly enters into, as Trade Minister Simon Birmingham has urged, the “spirit” of the agreement.

Chinese Foreign Ministry spokesman Wang Wenbin asked recently what seemed to him to be a rhetorical question: “Between China and Australia, which country is breaching the principles of a market economy and the bilateral free trade agreement … and taking discriminatory measures? The facts are all too clear.”

They are indeed. A new Beijing government circular calls for “strengthening the (communist) party’s comprehensive leadership over foreign trade”. And Australia is far from the only target.

China is brimful of confidence in its commercial aggression because it is still performing better than any other large economy. But it is in the medium to longer term, rather than immediately, that its underlying challenges will develop more troublingly.

Economic policy was pretty consistent under the leadership of Xi’s predecessors Jiang Zemin and Hu Jintao — cautious and steady opening, and modernisation of production.

Leading Chinese economists and central bankers produced with the World Bank in 2012 a powerful report laying out a reform agenda to complete Deng Xiaoping’s liberalising vision. This would have steered the economy towards a new and more sustainable direction — from being driven principally by investment, credit and exports, to one more ­reliant on services and domestic consumption, with the market playing a decisive role in allocating resources.

But Xi, who was then taking charge as party general secretary, was focused not on the economy but on his anti-corruption campaign to purge and purify the party, the key platform that had brought him the senior leaders’ endorsement.

Steadily, as he personalised, centralised and restructured China’s governance, he also rowed back the party to resume its centrality in the economy.

Xi’s Thought, now enshrined in state and party constitutions, is on “Socialism with Chinese Characteristics for a New Era,” emphatically not on Deng’s old reform-and-opening-up era.

Meanwhile, China’s three chief drivers of growth this century — credit, internal migration and exports — have become increasingly constrained. China’s capacity for further overseas investment has become diminished, its debt surpassing three times its GDP and buying decreasing increments in productivity.

A new report on economic risk in China for the Centre for Strategic and International Studies in Washington states: “Investors are now questioning Beijing’s guarantees for risky investment products, bonds, companies and even banks”, since the failure last year of Baoshang Bank in Inner Mongolia, followed by four other banks being forced to restructure.

It says that COVID-19 and the resulting economic slowdown “have compounded the credit risks within China’s financial system; more banks are being asked to roll over loans to highly indebted corporates that are short of cash, and thousands of small services sector businesses have closed their doors, perhaps permanently”.

And China is struggling to challenge the use of the US dollar as the world’s reserve currency. The yuan is used for only about 2 per cent of international payments, compared with the euro at more than 30 per cent and the US dollar at more than 40 per cent.

The widely respected 16-year governor of the People’s Bank of China, Zhao Xiaochuan, who retired in 2018, said recently that China could not promote the use of the yuan while maintaining rigid capital account controls. “It seems we have a kind of mistrust or even a fear of the market and prices, including the exchange rate,” he said.

Beijing has responded in part by instead becoming the great champion of digitalised currency and by using blockchain in trade accounting. China already controls two-thirds of the computing power to mine Bitcoin. But this cuts both ways. In 2019, more than $US70bn ($95bn) of cryptocurrency was shifted overseas from digital wallets in China — likely the elite shifting wealth elsewhere.

China is now directing its diminishing capital stock back home rather than abroad. So the Ministry of Industry and Information Technology is targeting 105 new projects for an average of $US1bn each, and the CDB a further $US60bn for 24 projects.

Shifting supply chains

One aim is to shift this stimulus from “old infrastructure” towards new technological infrastructure, including the 5G mobile network. But that move is encountering consumer resistance, with current 4G speeds — and almost ubiquitous reach — appearing sufficient for most Chinese people, primarily today concerned about their savings and their jobs.

Internal migration to the cities has slowed as the manufacturers that used to bring people from the countryside are rapidly robot-ising, and it is tough for rural folk to find alternative work in services.

Global supply chains are shifting, due to rising costs in China and to a desire to diversify sources from China to reduce political risk, with China having pursued economic sanctions against so many countries in recent years.

Germany is China’s most important market in Europe, and the Federation of German Industries, the BDI, has complained that China “provides extensive subsidies, above all to state-owned companies, along with other measures not in line with a fair and open market order”. Canada decided in October that a free-trade agreement with China, for which talks began four years ago, is no longer worth pursuing.

While China is expected to continue to dominate supply chains for a long time, trade patterns are changing. Moody’s wrote in a recent report: “The pandemic will accelerate the diversification of global supply chains and more manufacturing may move away from China.”

Young Liu, chairman of Taiwanese company Foxconn, which makes many of the world’s top tech consumables, including the iPhone, and employs about a million people in China, agreed, saying that “the past model where manufacturing is concentrated in just a few countries like a world’s factory will no longer exist”.

The pandemic has intensified such longer-term trends, rather than triggering them. The boom in demand for Chinese products this year, driving its present recovery, is substantially the result of the massive government funding programs in Western countries. In comparison, little financial help has been directed to households in China which, as Gavekal’s Andrew Batson and Thomas Gatley say, “focused instead on supply-side ­efforts to control the virus and get companies operating again”.

The world is changing, and China — which has in recent years grown used to driving development — now needs to change too.

The revived socialism of Xi’s new era partially worked at first. China’s continuing investment in upgrading infrastructure and in education, and its ready access to the world’s top innovatory technologies by attracting global tech leaders to operate there, helped ensure that rapid growth continued in the post-GFC era of the first half dozen Xi years.

Xi’s tough challenge

But the perfect storm of Donald Trump’s “trade wars” coinciding with COVID-19 has pushed Xi to take on his toughest challenge yet: steering China towards a new economic template, which he introduced at a Politburo meeting in mid-year. It is called “dual-­circulation” and it will take centre stage in the 14th Five-Year Plan, whose details will be launched formally at next March’s National People’s Congress session.

The core inner circuit comprises the domestic economy; the outer circuit comprises China’s international connections. The aim, Xi said, is to “fully bring out the advantage of China’s super-large market scale and the potential of domestic demand to establish a new development pattern featuring domestic and international dual-circulations that complement each other”.

Xi said this does not mean lessening or closing the open nature of China’s economy. But he wants jobs to rely on Chinese more than foreign markets, and more food to be grown at home not imported.

The consumption share of China’s economy is low today — only 39 per cent of GDP — compared with 66 per cent in the US, and it is well below the 45 per cent reached in China itself at the start of the 2000s.


Another Gavekal researcher, Gilliam Hamilton, says: “It is very difficult to significantly change households’ propensity to change, and China’s government has no track record of reliably being able to do so. A new government slogan is unable to make a big difference.”

Demand has not been driving the economy as it should. That’s understandable, since household debt as a share of disposable income is now higher than in the US. And investment by private firms, another important driver of consumption, is constrained by state banks’ reluctance to lend to them.

Long postponed finance system and fiscal reforms will also need to be implemented for dual-circulation to work fully. And upgrading the services sector requires greater foreign involvement, as happened a generation ago in manufacturing, while boosting consumption means putting more money in workers’ pockets and less in enforced savings, including to keep bloated government corporations afloat.

Michael Pettis, a finance professor at Peking University, said: “Economic recovery in China requires a recovery in demand that pulls along with it a recovery in supply, but that isn’t what’s happening; China’s ‘recovery’ is largely an exacerbation of the problems that have long been recognised by Beijing … which it has found politically very hard to manage”, since rebalancing involves a massive shift of wealth — and with it, political power — to ordinary people.

This will not be easy for a party whose absolute power has grown under Xi. Not renowned for his flexibility or pragmatism, can he now accommodate that modernising program he had originally inherited as he came into office?

Ubiquitous party guidance and a strong dose of protectionism, both a more natural fit with Xi’s core ethos, loom large as barriers to such overdue reforms. China’s private sector is already struggling under the weight of “party first” policy. Guidelines on Strengthening United Front Work of the Private Economy in the New Era, released by the CCP in September, say that it aims “to build a backbone team of private businesspeople that is dependable and usable in key moments”.

Business people must “maintain high consistency” with the party, its guidelines say, reinforcing a recent speech in which Xi said “patriotism is the glorious tradition of excellent entrepreneurs in China.” All key sectors remain firmly in party-state control. No one talks anymore of privatisation.

Beijing underlined this earlier this month by axing, just two days out, what was to have been the world’s largest ever float, of the $US35bn Alibaba finance sector spin-off, ANT. Alibaba founder Jack Ma branded the state banks as “pawnshops,” and said about governance agencies: “We should not use the way to manage a train station to regulate an airport.”

The party stepped in, with the People’s Daily stating: “There is no so-called Era of Jack Ma; he is only part of the era.” Which, the float kybosh underlined in spades, is Xi’s New Era.

Besides elevating Leninism to levels of previously undreamt-of control and surveillance, Xi has turned into a modern Marxist. He no longer believes the state must own the means of production to control a sector. But every organisation, every company, in China must contain a party branch to guide policy and choose its leaders.

Li Youwei, a former party secretary of Shenzhen, wrote recently that Xi’s program for such fusion between China’s private and state companies is causing widespread concern among businesspeople, stating: “We are standing at a crossroads.”

Employees in the workshop of a lithium battery manufacturing company in Huaibei, eastern China's Anhui province. Picture: AFP
Employees in the workshop of a lithium battery manufacturing company in Huaibei, eastern China's Anhui province. Picture: AFP

Ageing population

The country is also at a demographic crossroads, with the ending of the one-child policy failing to reset population growth, and with a quarter of the rural population, about 124 million people, expected by the Chinese Academy of Social Sciences to be older than 60 by 2025, coping with a state pension of less than $100 a month — raising further problems for this attempted shift towards a consumption-led economy.

China also stands at cultural and educational crossroads. It has depended crucially for its rapid growth to date on appropriating or building on technologies developed elsewhere.

For instance, today it spends more on importing semiconductors than it does oil. So Xi’s “Made in China 2025” scheme is intended to provide the domestic dual-­circulation sector with the innovatory grunt to supply the sophisticated parts required by giant tech companies such as Huawei that were previously imported.

But Beijing-based Wang Xiangwei, editorial adviser to the South China Morning Post, wrote recently that while “a free flow of ideas and opinions is vital to drive innovation … unfortunately the opposite is happening in China: the government is cracking down hard on dissent and tightening the muzzle on the media. Academic freedom is also suffering as researchers and professors have to strictly toe the party line or face stern punishment. Without freeing the mind first, innovation is hard to achieve.”

Unlike the old USSR, China’s economy is internationally enmeshed and irreplaceable, will remain huge, and will continue to offer immense opportunities for Australian businesses.

But Australia’s reticence to invest there, or to appoint to senior executive or board roles Australians who have experience of living and working in China, or in Asia generally, limit the country’s China-savviness. This is also being diminished by the success of Beijing’s clever wedge that we must choose between preferencing our economy or our security.

In the grander and longer game, Xi’s own Chinese Dream is at stake. If Xi — who steadfastly declines to elevate a successor — fails to meet his greatest challenge, to transform the economy, his other achievements will come into play, and the party may struggle to keep control.

And in that process, Australia’s own political, strategic and economic dreams — and nightmares — will need to be reshaped.

One of Xi’s favourite films is The Godfather, who made offers people couldn’t refuse. In 2021, he will make many offers, or threats disguised as offers, such as commercial deals in return for UN votes, for friendly rhetoric, and for refusing to “contain” China.

Australia and other partners are likely to refuse such offers, and instead to intensify efforts to diversify economic opportunities.

And some in the party’s own middle ranks are starting to murmur that Godfather Xi has done well so far, but instead of endless struggle, surveillance and stoushes it is now time to consolidate, to chill, to enjoy at last the fruits of their hard-won prosperity while it is within their grasp.

Rowan Callick, twice a China correspondent for The Australian, is an industry fellow at Griffith University’s Asia Institute.