|China Will Be on Top of the New World Order|
By Leslie P. Norton
June 14, 2019 8:00 a.m. ET
Louis-Vincent Gave. Illustration by Ryan Melgar
Thirty years after the Tiananmen Square massacre, China has seemingly become a problem without a solution for the Trump administration. The trouble is that China’s growing strength is fundamentally related to the U.S.’s own behavior regarding the dollar. This is one of the many stimulating points in Louis-Vincent Gave’s recently published book Clash of Empires: Currencies and Power in a Multipolar World. The French-born Gave is a clearheaded analyst who, in 1999, founded GaveKal Research with his father Charles Gave, then working at Alliance Capital, and Anatole Kaletsky, an economic journalist. Clearly, GaveKal clients appreciate the firm’s provocative views: Today, they include 800 financial institutions, asset managers, corporations, and government agencies. We recently checked in with Gave about the U.S.-China trade war and his new book; an edited version of our conversation follows.
Barron’s: The Trump administration just called off a tariff threat against Mexico. Will a Chinese deal follow soon?
Louis-Vincent Gave: We’ve argued for the past year that people were looking at the trade war completely wrong. Most people see this as Donald Trump being obsessed with tariffs. He pressured Canada, Mexico. Nobody in the U.S. wants to hurt Canada, or France, or Mexico. China is different. A broad spectrum of the U.S. political establishment sees the rise of China as potentially deeply destabilizing for the U.S. position in the world. Until Xi Jinping became leader in 2012, China was an inward-looking empire that had too many problems at home and wasn’t looking to go abroad. Now they’re talking about One Belt, One Road; they’re going to fund the Silk Road Fund, the Asian Infrastructure Investment Bank, copy-and-paste the institutions that the U.S. built post—World War II, and build themselves their own empire out here in Asia.
The blowup in the past month is that both the U.S. and China thought they had pretty strong hands and could go all in. Now China is in full-on nationalist mode, talking about unequal treaties back to the Opium War. How do you walk yourself back from that unless the U.S. gives in massively? And if you’re Trump, at this point, what do you gain by compromising with China?
What happens at the G-20 meeting this month?
For Xi Jinping, it would be politically hard to compromise very much. If he signs off on an unequal treaty, then he’s the Qin emperor, the guy who sold China down the river. I think it’s 85% odds you don’t get a deal. If in a year, because of the massive disruptions in the supply line and so on, we end up with a big recession, then the U.S. and China will have to compromise.
Your new book is about the paradigm shift in the global order.
Until the 2008 crisis, China was very happy to do all its trading in dollars, which it earned by selling stuff to the U.S., then used to fund trade with Indonesia, Korea, wherever else. In 2008, the American banks blew themselves up and Asian trade collapsed because there were no more banks to fund it. In 2009, 2010, China started telling Indonesia, Korea, et cetera, that trading in dollars makes them dependent on the willingness and ability of American banks to fund their trade. Instead of a committed relationship, it was a ménage à trois. And in a ménage à trois, there’s always one guy too many. So China said, “Let’s do more trading in renminbi.”
To do that, China needed to start liberalizing its currency market and open its bond market to foreigners. The past 10 years have been a story of the internalization of the renminbi. The aim is pretty simple: to gradually but surely replace the U.S. dollar, first as Asia’s trade currency, and down the road as an important commodity currency. One of the most important events of 2018 was the launch in March of the RMB oil futures contract. From a standing start, 12% to 13% of oil futures are now traded in renminbi in Shanghai. Now you have the opening of the gold window in RMB in Shanghai. If you’re Russia, you can sell oil to China for RMB, and then exchange the RMB for gold, and bring the gold back to Russia. It’s a very important change in the global financial architecture.
You write about the weaponization of the dollar.
The U.S. is using the dollar as an instrument of foreign policy. A defining moment was in 2014 when the U.S. imposed a massive fine on BNP Paribas [ticker: BNP.France] for making U.S.-dollar loans in Sudan. There were no laws in France against dealing with Sudan. The U.S. said that if you do dollar business, the U.S. Treasury can look at any deal you do. It’s extra regulations, extra cost, extra lawyers. You’re in a ménage à trois once again.
Another example is the sanctions against Iran. Under the Obama administration, Iran came in from the cold, [French oil-and-gas company] Total [TOT] goes back in and invests $1 billion, and then the new administration says you can’t do business in Iran—Total has to get rid of this investment. If you’re China, what you take from this trade war is: The less you do in U.S. dollars in coming years, the better.
What does the new world order look like? Will the dollar be invited?
It’s the world’s main reserve currency and will remain so for a long time. But if your biggest client tells you they want to trade in renminbi, it’s hard to say no. The world will have three empires: the U.S. empire, the Chinese empire, the European empire. Let’s start with China, which tends to say what they’ll do and do what they say. Xi Jinping has an imperial goal—building all these roads, and ports, and pipelines across Asia and everything leading back to Beijing. The vision of the U.S. empire is to contain China.
What is Europe’s role?
Europe just wants to survive, not only over the next 30 years, but until the end of next week. The biggest advantage of building an empire is your currency gets adopted in more and more places, so you have bigger seigniorage, which is the money you make by printing money. Europe tried to keep growing into Ukraine, into Georgia, and Russia put its foot down.
Every stalling empire confronts the problem of keeping a diverse population happy while maintaining a certain level of centralization. One of the biggest anomalies in the markets is that the five-year German government bond is yielding minus 50 basis points, and the Swiss is yielding minus 90. Having negative interest rates is crazy because the market is telling you it knows more about the future than the present. Is the German yield telling you the euro can’t survive, or the whole system will blow out? In the next 10 years, this will blow up.
The current U.S./China clash is about telecom supremacy.
The U.S. has decided that it needs to contain China, and its great comparative advantage is technology. They’re going to take Huawei down. That could really turn around and—excuse my French—bite you in the ass. If Apple can’t produce in China, or can’t sell what it produces in China back to the U.S., or if China starts blockading its product, you’ve destroyed one of your biggest companies. Samsung Electronics [5930.Korea] will pick up the pieces. Technology is one of the biggest parts of the U.S. stock market. U.S. investors are as exposed to U.S. stocks as they were in 1999. The big difference between then and today is that the average U.S. investor is much older. When you’re 30 years old, a bear market gives you the opportunity to buy more stocks cheaply. When you’re 65, it is more problematic. There will be casualties in tech at a time when you can’t really afford a bear market. I like to make the comparison with the Battle of Agincourt, where the French had five times as many troops as the English and were so sure of our superiority, and the English slaughtered us.
What is the next battlefield?
Potentially energy. If the price goes up, whether from enforcing a blockade against Iran or Venezuela, it leads to a rapid deterioration in China’s current account. In December, China’s year-over-year oil import growth was 21%, the highest in 10 years for an economy that’s been slowing. China is stockpiling energy like crazy. The card China can play now, to get Trump back at the table, is to create disruptions in the U.S. markets. One way is to tank the oil price, as we saw in 2016.
How should people be positioned?
We’re moving from a world that was constantly globalizing to one breaking up into three different empires, each with their own currency, reference bond market, supply chains. There are massive investment implications. So if the U.S. and China are now going to try to trip each other up, it’s a bit like when two big dogs fight—you want to stay away.
In any market, there are two guys that matter: the rentier and the entrepreneur. Historically in the U.S., the entrepreneur always does better than the rentier. In the U.S., I see no reason to own U.S. Treasuries. Policy makers are telling you they want inflation to accelerate, and your bonds will be worth nothing over time. In China, policy makers are saying they want to internationalize the renminbi, but being a rentier has been much better than being an entrepreneur. So buy your bonds in China and your equities in the U.S.
U.S. tech is no longer as entrepreneurial as it used to be, and the U.S. government is undermining it. So I wouldn’t put so much in tech. The U.S. has a very dynamic energy sector that isn’t replicated anywhere, which is beaten up and cheap. The U.S. also has a consumer that never gives up. Today, real estate is perhaps the most interesting way to play it.
When does China’s 10-year bond replace a 10-year U.S. Treasury as the investment of choice?
In the U.S., never. But within Asia, it will happen over the next five to 10 years.
What about in Europe?
Europe is, increasingly, in essence, a high-beta play on emerging markets. I’d rather take my risk in the emerging markets. Europe is increasingly like Japan in the late 1990s and 2000s, where the banks are flat on their backs and can’t make money because of the negative yield curve, and utilities are getting overregulated. You have some great exporters, but is Unilever [UN] so much cheaper than Procter & Gamble [PG]?
What’s your view of the dollar?
We’ve seen the top. Everything that’s happened over the past few years should have been massively bullish—the U.S. moving into energy independence, the Fed being the only central bank to tighten, bad news out of Europe, question marks over China’s long-term direction. But the dollar has really been range trading since 2015, with the DXY [the U.S. dollar index] in a fairly tight range. Countries that favor the rentier tend to have a strong currency; those that favor the entrepreneur have a weaker one. I’m bullish on pretty much every one of the Asian currencies. Sterling, the Canadian dollar, the Mexican peso are cheap. And while it’s hard to be a superbull on Europe, we may have seen the lows on the euro.