The Breakdown - What's Behind Growing US-China Tensions?

Starting point is 00:00:00 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexus.com, and FTCS, and produced and distributed by CoinDesk. What's going on, guys? It is Wednesday, July 27th, and today we are talking about what is behind growing U.S.-China tensions. A quick note before we get into this, there are two ways to listen to the Brexswain to the Brexie. Breakdown podcast. You can find us on the Coin Desk Podcast Network where the show comes out every afternoon and is featured alongside other great Coin Desk shows, or you can listen on the breakdown-only feed, which comes out a few hours later in the evening. Wherever you listen, if you are enjoying

Starting point is 00:00:50 the breakdown, I would so appreciate it if you took the time to leave a review or a rating. It makes a huge difference, and I appreciate every one of you who takes the time to do that. Also, a disclosure, as always, in addition to them being a sponsor of the show, I also work with FTX. Now, today is, of course, FOMC meeting day, where we will learn if the Fed decided to raise rates the anticipated 75 basis points to match last month's hike, or if they went all the way to a 100 basis point hike, a full percentage point raise, something that hasn't been seen since 1981. What they do and how the market reacts will set the tone for the next two months until

Starting point is 00:01:30 the September meeting, which many market commenters see as really the key in determining what the rest of the fall looks like when it comes to monetary policy. All of that will be the focus of tomorrow's show after I have a chance to not only see what the Fed did, but see how people are responding to it. In the meantime, however, there has been a key geopolitical story that has been getting louder and louder and punching through into big headline awareness. And that, of course, is rising U.S.-China tensions. Yesterday's Bloomberg headlines told the whole story. Biden will speak with Xi on Thursday as U.S.-China ties work. Werson. Underneath that headline were three more. Pelosi's peers say don't cave to China over

Starting point is 00:02:10 potential Taiwan stop. U.S. senators call for sanctions on Russian oil sales to China. China getting, quote, seriously prepared for Pelosi visit to Taiwan. So what is actually going on here? Well, as you can see, the key surface-level issue of late has been the potential of Nancy Pelosi visiting Taiwan. Taiwan sovereignty, of course, has been contentious since the 1940s. The People's Republic of China asserts that Taiwan is a Chinese territory, while the Republic of China in Taiwan maintains an independent democratic governance over the region. The U.S.'s relationship has been tense, weird, indirect, sometimes direct, ever since. We've had diplomatic and defense relationships with Taiwan since 1954, ranging from official recognition and mutual defense treaties to indirect relations

Starting point is 00:02:56 and military hardware provisioning. House Speaker Nancy Pelosi had been planning to visit Taiwan in August. This would be the highest ranking U.S. government official to visit since House Speaker Newt Gingrich 25 years ago. Obviously, China, both in terms of its economy, its military disposition, its political disposition, and its place in the world has changed dramatically in those 25 years. This trip had originally been planned for April but was canceled when Pelosi tested positive for COVID. Former defense officials visited in March as an envoy from the White House. Beijing, as you might expect, strongly opposes the visit. with a spokesperson for the Chinese Ministry of Foreign Affairs urging U.S. officials to, quote,

Starting point is 00:03:35 strictly adhere to the U.S.'s one China policy. Quote, if Speaker Pelosi visits Taiwan, it would seriously violate the one China principle and the stipulations in the three China-U.S. joint communicates and harm China's sovereignty and territorial integrity. They went on to say that the visit would have a, quote, severe negative impact on U.S.-China relations, and went on to demand that Washington halt official interactions with Taipei and, quote, stop creating factors that could lead to tensions in the Taiwan Strait. The spokesperson even said that China would take, quote, strong and resolute measures to safeguard its sovereignty and territorial integrity. Indeed, earlier today, Beijing said that the

Starting point is 00:04:11 United States, quote, bears all the consequences if House Speaker Nancy Pelosi proceeds with the visit to Taiwan. Apparently, President Biden has discouraged the visit, according to White House pool reports. Biden said, the military thinks it's not a good idea right now, but I don't know what the status of it is. Whether they think it's a good idea or not, the military is planning in case Pelosi does decide to go. From the Associated Press today, quote, officials told the Associated Press that if Pelosi goes to Taiwan, still in uncertainty, the military would increase its movement of forces and assets in the Indo-Pacific region. They declined to provide details but said that fighter jets, ships, surveillance assets, and other military systems would likely be used to provide overlapping rings of protection

Starting point is 00:04:52 for her flight to Taiwan and any time on the ground there. So here we have, of course, on the surface level, an issue of should Pelosi go right now or not. But for many, this is about a much larger question of China policy. Hal Brands, the Henry Kissinger Distinguished Professor at John Hopkins School of Advanced International Studies, writes in Bloomberg today, in one sense, this controversy over Pelosi's proposed visit is just part of the standard arm wrestling between Beijing and Washington over Taiwan's place in the world. But there may be something deeper in Biden's anxiety about a potential Taiwan crisis,

Starting point is 00:05:24 a realization that America's China policy is courting dangers the U.S. isn't ready to handle. The piece goes on to have a few interesting notes. One is the domestic implications for China. Brands writes, The contest is now interacting with the internal workings of China's autocratic political system. Taiwan may be an area where President Xi Jinping can't afford to look weak as he seeks a third term in office at a Congress of the Chinese Communist Party this fall. Brands also notes the lackluster plan.

Starting point is 00:05:54 planning and strategy from the U.S. as relates to China policy writ large. Quote, American trade policy toward Asia was absent under Trump and continues to disappoint under Biden. His Indo-Pacific economic framework is more notable for what it lacks, namely expanded access to the U.S. market for allies and friends than what it contains. Proposals to form a united Democratic front against Chinese economic coercion have mostly gone nowhere. Congress is finally poised to pay for major investments in semiconductor production and scientific research, only after the measure had languished for a year. Despite some constructive steps by the Trump and Biden administrations, American money still flows into companies with ties to China's military

Starting point is 00:06:33 and human rights abuses. End quote. Now, there's also a condemnation of failures of defense spending, but I want to use these two points, one about the domestic implications in China and what this all means for President Xi, and then second, the American failure to have a coherent strategic framework specifically as relates to our economic relationships with China as a way to most of the rest of this conversation today. Let's first look at domestic China. There has been a ton of chatter about, in particular, banking problems in that country that have been all over Bitcoin Twitter. Kyle Bass, who very admittedly, you have to know his biases, is a China bear. You can go listen to the show that I did with him a year or two ago now at this point, writes, bank runs are happening

Starting point is 00:07:21 all over China. It's important to note that the Chinese banking system represents 350% of Chinese GDP on balance sheet, while the U.S. system is only 100%. One of the largest lending categories of Chinese banks is real estate. Developers are filing bankruptcies at a record pace. Moody's has downgraded 91 Chinese property developers this year alone, while Moody's has only downgraded 54 over the past decade before this year's actions. China's banks are insolvent. The CPC is likely to brutally suppress the bank runs in the near-term, as they can't allow them to spread further. It's not just small banks.

Starting point is 00:07:58 The biggest crowd over the weekend was found at the Bank of China, one of the largest SOE banks. So what is actually going on behind this tweet? Well, in early July, it was reported that four banks in Hannan province had closed withdrawals, locking depositors money away. Protests ensued with violent police intervention clearing the protests after several days. In one of the crazier parts of the story, at least to us here, authorities admitted to turning the health codes of more than 1,000 people read,

Starting point is 00:08:24 in order to prevent them from traveling to protest. Reports vary on how much money has been with the South China Morning Post, reporting that $6 billion worth of deposits have been held improperly. One big issue with this banking failure is that there were allegations of fraud within these institutions. So the challenge for the Chinese central government is, if that's true and they guarantee deposits or compensate depositors, they might also be benefiting the perpetrators of financial fraud. Reports from early in July, as the protests began, said that the People's Bank of China would be verifying account holders and making legitimate depositors whole. Customers at the Four Trouble Banks have reportedly begun to receive repayments from the China

Starting point is 00:09:05 Banking and Insurance Regulatory Commission on accounts below 100,000 yuan, which is about $20,000. $20,000. An official probe into the matter found that at least one private investment firm had colluded with bank employees to appropriate deposits and market financial products online before transferring the funds through fabricated lending agreements. I haven't talked that much about these bank protests, not because I don't think they're important, but because it's simply hard to get really good information. Is there actually widespread-scale fraud going on,

Starting point is 00:09:33 or is that just a convenient talking point for the government who doesn't want to deal with potential insolvency issues? I don't know. But at this point, these things are being reported on by numerous outlets both in China and in the West, so just take everything with a grain of salt, but at least I can give you that much information. In times like these, security of your assets should be your number one priority.

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Starting point is 00:11:36 One of the things that's interesting about the Chinese real estate market is that it's common practice to finance a home before construction is complete. The problem is that right now, many purchasers are paying mortgages on property that may never be completed. Large property developers have been distressed for over six months, with numerous rumors swirling starting late last year around the solvency of these firms. Now it appears that customers are starting to withhold payment of mortgages on these unfinished homes. A few weeks ago, we started to get reports of small mortgage boycotts, in which customers were refusing to pay mortgages related to several dozen property developments. This has now snowballed, and currently 301 housing projects are affected by the boycott across 91 cities. The boycott is made in the market.

Starting point is 00:12:18 most acute, again, in Hanan province where 61 projects are affected. A crowdsourced document titled We Need Home has been set up to support the movement, and approximately $297 billion in loans are reportedly affected, with hundreds of thousands of letters being sent by homebuyers threatening to stop payment. An anonymous executive at a private development told Reuters, quote, it's a domino effect. No new homebuyers will buy our unsold apartments in the presale, but we need to use that money we get from selling half or two-thirds of the units to complete construction. Regional governments are being urged to backstop housing developers and guarantee the delivery of unfinished homes. Some local governments have already set up working groups to deal with this issue.

Starting point is 00:12:57 Still, Rory Green, the chief China economist at T.S. Lombard, explained that this may not be enough to calm the risk of financial contagion. Quote, we think a stronger indication of central government support will be needed, including liquidity provision for certain projects. The Halt and mortgage payments is very small in scale, but until a clear stance on defaulters is taken and the spread of deliberate mortgage delinquencies is stopped, caution is needed. To get a sense of the scale of this problem, housing is a much bigger asset in China than it is in the West. Approximately 70% of household wealth is held in housing in China, compared to around 30% in the U.S. China's $1.7 trillion housing market is the largest in the world and is seven times larger than

Starting point is 00:13:37 U.S. housing. Sales of new homes by large developers has already dropped by 43%. And importantly, it's not entirely clear that the PBOC has the capacity either financially or technically to backstop a collapse in the housing sector and the associated lenders scattered throughout the country. So now Beijing has a stark choice, either make good on the implicit backstop of the Chinese financial system by providing the necessary liquidity to maintain long-term stability in the banking sector at the risk of rewarding some financial fraudsters, or try to discipline the banking sector, moving slowly on these liquidity backstops and risk the public losing confidence in the banking system. China has over 4,000 small and medium-sized lenders that collectively manage

Starting point is 00:14:18 $14 trillion in assets. Confidence in these banks has already diminished since 2019 when the government seized a lender for the first time since 1998 and imposed losses on some creditors. An anonymous scholar told the South China Morning Post, quote, the banks were approved by the banking regulator, and deposit is different from investment. It has a big impact on public confidence. Now importantly, this is introducing political, not just financial risk. Dali Yang, a political scientist from the University of Chicago, said this is a credibility crisis, involving not just a few rural banks in Hannan province, but a large number of grassroots accounts holders across the nation.

Starting point is 00:14:52 From a Marxist framework, finance and economic risks are essentially political risks, and that's why many are concerned with containing the problem from spreading further. We can see that the authorities have offered a political strategy in an attempt to dissolve a political crisis, but this is not a real solution. The real solution for the banking sector and governments is to figure out and coordinate where to find the money to cover the losses. Alfred Wu, an associate professor at Northern University of Singapore, explained that this incident is also exposing the limits of the Chinese surveillance state's ability to maintain stability. Quote, the crisis also shows that some social instability

Starting point is 00:15:25 just can't be maintained when it comes to hurting the fundamental interests of the people. There is no amount of sophisticated digital surveillance or security muscles that can contain grievances at a level of life or death for the public. Now, there is a larger political context for this as well. The Chinese Communist Party will hold its 20th Party Congress in Beijing in October. Xi Jinping will seek election for a third five-year term as general secretary of the CCP and president of China. There have also been longstanding rumors that Xi will seek a position as president for life. Now there's a general understanding that the stakes are extremely high for Xi entering the party Congress. Between zero COVID policy, economic woes, and geopolitical tensions,

Starting point is 00:16:06 there are many questions being raised about the quality of his leadership. The point of bringing this all up is that when we look at what's happening with Nancy Pelosi and Taiwan and China's response to that, there is this entire set of domestic issues going on as well in the context of a politician who wants to not only remain in power but potentially claim even more power. So what about the U.S.? What about our side? What is the U.S. to do? First of all, one of the big issues with Taiwan is the semiconductor chip issue. And this gets to the second part of Howe Brand's editorial. Taiwan is a geostrategic linchpin in part because of its dominance in advanced computer chip manufacturing.

Starting point is 00:16:46 Taiwanese chipmaker TSM currently produces 56% of advanced semiconductors. A shortage in computer chips revealed the fragility of the U.S. supply chain to disruptions in the sector during the past couple of years. Today, as I was recording this, the Senate passed legislation that includes $52 billion in grants and incentives for U.S.-based semiconductor manufacturing. It also includes an estimated $20 billion in tax credits to onshore production of chips. Commerce Secretary Gina Raimondo warned of the economic risk of foreign dependence in this sector. Quote, if you allow yourself to think about a scenario where the United States no longer had access to the chips currently being made in Taiwan, it's a scary scenario. It's a deep and immediate recession.

Starting point is 00:17:28 It's an inability to protect ourselves by making military equipment. We need to make this in America. We need a manufacturing base that produces these chips. at least enough of these chips here on our shores, because otherwise will be too dependent on other countries. End quote. The U.S. currently purchases 90% of advanced chips from Taiwan. Even beyond semiconductors, you're starting to see new rhetoric out of the Biden administration for a different type of thinking. During a visit to South Korea, U.S. Treasury Secretary Janet Yellen gave a foundational speech on the new Biden administration doctrine of friend shoring. Yes, that is a word

Starting point is 00:18:01 that they actually used. Basically, it's an initiative to strengthen supply chain. by encouraging trusted allied nations to boost capital investments in each other's territory. The speech drew attention to the role the Russian war in Ukraine and the pandemic have had on global supply supply. Quote, together they have redrawn the contours of global supply chains and trade. It's clear that no country will be spared from the consequences of Putin's illegal war of aggression. All responsible countries must unite in opposition to this war and work together to end it swiftly. The speech draws a stark line on the risk posed by, quote, unreliable countries

Starting point is 00:18:32 in existing supply chains. The rationale for friend-shoring, quote, friend-shoring is about deepening relationships and diversifying our supply chains with a greater number of trusted trading partners to lower risks for our economy and theirs. Working with allies and partners through friend-shoring is an important element of strengthening economic resilience while sustaining the dynamism in productivity growth that comes with economic integration.

Starting point is 00:18:54 So this is a bit different than the pure on-shoring sort of rhetoric, the idea that everything has to come back to the U.S. but it is still a redivision of the world into our allies and not our allies, where before the world was just an American protectorate. Whether the idea of quote-unquote friend-shoring remains, it's clear that there are significant geopolitical shifts underlying this. So where are we today? Well, President Biden will be speaking with Chinese President Xi on Thursday. It's the first official call between the leaders since March. U.S. Ambassador to China, Nicholas Burns, said in June that relations between the rival nations had deteriorated to their

Starting point is 00:19:30 lowest moment since diplomatic channels were opened in 1972. Depending on when that call happens, I'll have more about what was actually discussed, whether any progress was made, and where the tide seems to be shifting. For now, I hope you have enjoyed and found informative this little bit of background. Obviously, there's much, much more going on than I've just captured, and I think it goes without saying, but in no way am I a China expert or a U.S.-China relationship expert. So take everything with a grain of salt. And as always, as we say in this industry, do your own research. I want to say thanks again to my sponsors, nex0.io, chain aliasis and FtX, and thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.

The Breakdown - What's Behind Growing US-China Tensions?

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