TWS: July 23-30, 2020

Stay in the know on China business insights

Graph of the Week | Economics

A geopolitical weapon? The cornerstone of China’s economic policy? China’s role as the second largest holder of US treasury bills is often seen as both.

China’s T-bill holdings peaked in August of 2017, the same month in which President Trump ordered the “Section 301” probe into unfair Chinese trade practices. Ever since, China has been dumping T-bills to reduce its exposure to trade war shocks – a deceitfully perilous act that requires extreme care.

If China were to offload its position into global markets too suddenly, the flux in supply and demand would push down treasury prices and drive up yields, spiking the cost of debt for Washington while sinking the value of Beijing’s unsold holdings. But the longer China sits on its holdings, the more risk it faces that the US Fed devalues the USD through quantitative easing, putting Beijing as Uncle Sam’s Uncle Sam in the hot seat. Instead, Beijing is cruising along the middle road by steadily reducing its holdings, but the road ahead is long.

Bottom line: Beijing’s massive T-bill holdings put China in the ironic position of having its financial wellbeing tied to the fate of the US economy…and right now the dynamic duo of the pandemic and the trade war are blowing up worse than a botched chemistry experiment.


Policy

Panda Diplomacy Gets a Black Eye

In a move packing more heat than a mouthful of Sichuan chilis, China ordered the closure of the US consulate in Chengdu last Friday. By shuttering the Chinese consulate in Houston, it was only a question of which US consulate would fall prey to China’s retaliation, and how soon. After receiving a Monday move-out deadline, US consular officials in Chengdu have lowered the flag and shipped out.

So, out of the 6 (now 5) US consulates and 1 embassy in China, why Chengdu? Let’s play a round of two truths and a lie to find out…we’ll leave the answer at the bottom of the newsletter*:

  1. Chengdu is considered a secondary consulate, and China wanted to avoid further escalation by closing a lower impact location;
  2. Chengdu is the panda capital of the world, and China wanted to signify that ‘Panda Diplomacy’ had failed between the two nations;
  3. The Chengdu consulate played a role in one of China’s largest political scandals a few years back, and Beijing hasn’t forgotten.

Bottom line: Washington has urged China to show restraint, but with Washington’s latest 4-piece concerto on China – culminating with Pompeo’s symbolic speech at the Nixon library, the words will likely fall upon deaf ears. But, in the near-term, any major escalatory behavior from Beijing is unlikely.

Further Reading


Economics | Markets

Dazzling Like a Diamond in the Rough

Investors are going for the Gold as the precious metal’s price closed at $1,931 per ounce on Monday, its highest level since 2011. Amid the perfect storm of rocky US-China relations, declining interest rates, and a weakening dollar, global investors are searching for safer shores.

It’s typical for gold to fare well in times of uncertainty – and you’d be hard pressed to remember any time in modern history more uncertain than now. The looming threat of a complete breakdown in relations between the world’s two largest economies – and the seismic impact that it’d unleash on the global economy – has investors running for cover. Meanwhile, the Fed’s decision to continue slashing interest rates while the US dollar extends its 187% drop in value since March highs has the ‘safe-haven’ asset looking shinier by the moment.

Bottom line: Current valuations are pretty unbelievable, with markets closing in on pre-COVID highs as the world continues to flounder. But, with US-China tensions at all time highs, an anticipated Fed decision to keep interest rates low, and the possibility of a US$2 trillion stimulus package, it makes sense that investors would flock to Gold – after all, there’s wisdom in the old adage, “any port in the storm.”

Further Reading


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Finance | Markets

Bridging Chinese Bond Markets

Powers of interbank and exchange markets, unite! China is linking its disjointed bond markets, permitting investors from either market to trade bonds listed on the other.

The China Interbank Market is supervised by the PBOC and largely hosts public sector bonds and private sector money market instruments, while the smaller bond exchange market lists most corporate debt. Towards the end of 2019, China’s markets had US$143 billion of outstanding bonds, with roughly 87% circulating in the interbank market.

Segmenting the two markets was originally intended to isolate risk within the securities sector and banking industry. But over time, the two markets developed different trading systems, regulations, prices, and types of bonds, leading to low liquidity and decentralized trading. Foreign investors, for example, are largely restricted from trading corporate debt in the exchange market.

Bottom line: The bridge between the two markets will give foreign investors access to higher-risk instruments via the exchange market. The shift won’t happen overnight and will take heavy lifting to get right…but China is devoted to overhauling its financial system in its thirst for foreign capital.

Further Reading


Finance | Markets

Insurers, Place Your Bets

In a move largely unnoticed amid the cacophony of recent events, China’s financial watchdogs have raised insurers’ equity investment caps from 30-45%, encouraging the underrepresented institutions to double-down on their bets. With Chinese equity markets plagued by irrational ‘herd mentality,’ Beijing expects the move to help increase market efficiency and dampen volatility.

Because individuals typically lack the expertise and resources of institutions. China’s retail investor-dominated market is notorious for violent price swings that betray basic investment theory and level the playing field for weak companies with strong marketing departments. Upping investment caps will give institutions more influence over the market, which has historically proven to have a stabilizing effect on price movements.

Bottom line: Chinese equity markets are notoriously inefficient, and by giving institutions a bigger seat at the table, Beijing hopes to improve the health of domestic markets through smarter investment and natural selection.

Further Reading


Stay in the Know

The Hunt for Red Capital

To all you aspiring entrepreneurs out there: take heed! Despite a recovering economy, investors in China have been slow to pump money into young firms…and the trend is clear – the remainder of 2020 will continue to challenge startups’ resiliency.

New data on China’s VC industry reveals a grim reality: while the economic impact of the coronavirus batters portfolio investments, investors are shying away from early-stage funding.

Stay informed and lead the conversation on China’s VC Industry with TCG’s Industry Cheat Sheet!

Cheat Sheet


Finance | Markets

Seeking: Pen Sellers & Pink Sheet Traders

China’s NEEQ exchange is calling for a ‘Wolf of Wall Street,’ as it opens pink sheet trading for Mainland mutual funds via its new “Third Board.” The NEEQ is China’s primary host for penny stocks – highly speculative investments made infamous by the pink sheets of paper that showed the latest price quotes.

The NEEQ launched in 2013 as an alternative channel for SMEs to access financing opportunities, and by lowering the cost and complexity of listing requirements, it became the de facto listing platform for SMEs. The exchange eventually split listings into three trading tiers based upon risk profile, with the new Third Board, or ‘Select’ trading tier, composed of 32 top-performing penny stocks handpicked by financial regulators.

Bottom line: By dictating the risk-reward profile for the Third Board, regulators are attempting to attract institutional investment to the exchange, and through doing so, introduce much needed lubrication into the SME economy – a sector that Beijing has struggled to reach with stimulus. Unfortunately, with over two-thirds of the Third Board’s listings closing below their initial offering prices at the end of the first trading day, it remains to be seen who can step up as China’s Wolf to move those pink sheets.

Further Reading


Industry

AI in China: Open Sourcing and the Players Behind the Curtain

AI technology dominance is playing a larger role in China’s global ambitions. Now, Beijing and tech players alike are seeking to push the industry to the next level through AI Open Source Software – a framework that greatly influences innovation, shapes market norms, and cultivates healthy competition – making it a core component of China’s long-term AI strategy.

Full Article

*Answer to two truths and a lie: Truths: 1 & 3, False: 2

Further Reading

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