Exploring the Future of US-China Relations, Part 3

i'm jim haskell senior portfolio strategist earlier this autumn we collaborated with one of our clients on a multi-part exploration of u.s china relations joining me in this series are three people with extensive experience in the u.s china realm i welcome ray dalio our founder and co-cio kevin rudd the former prime minister of australia and david mccormick our ceo and a former senior official in the treasury and commerce departments as well as the national security council in the george w bush administration the conversations you will see in this series are drawn from a video cast with ray kevin and david and from a live session with our client which was captured on audio excerpts from these two sessions will make up the content for this series throughout this series you will hear us refer to three different scenarios for how the relationship could evolve first a high friction scenario similar to the current path of increased tensions second a lower friction scenario wherein the two countries reaches sort of detent and third an unlikely scenario marked by major reforms to china's policies and a return to the engagement model of the past decades in part one of this series ray kevin and david discussed the arc of the u.s china relationship how we got to this point and where we might go from here in part two they surveyed domains of economic competition between the u.s and china and considered how trade technology and capital control policies may change in the coming decade in the following podcast ray and kevin consider the implications of u.s china tensions on global markets and for investors they discuss how chinese economic policy may evolve and rey explains the importance of diversification and what that means in this new environment to begin with i asked ray to comment on china's long-term prospects and the challenges it faces including the debt overhang the audio follows you referred to the problems i've been intimately involved with them and the policy makers and i watch it and i would say can hardly think of a policy that i would have done that would be much different but you have to take the particular leadership when deng xiaoping's administration came in they do believe that from 2009 the g20 meeting and the issue of creating a lot more debt in the use of fiscal policy led to a rise in debt to gdp and so on and i've had very intimate conversations with those who are responsible at that particular point that was viewed as a bad policy and problems and so it was really in the second term of uh xi's term that uh luha was put in charge of dealing with the debt problems for the most part he was uh as vice premier and that they put into place guo shi ching who is responsible for really dealing with the triangular debt problem and so on so when i first went there basically my feedback to them and so on was that money is clogged at the top because five major banks lend money to state-owned enterprises and you couldn't get capital through the system then they had the uh development of the shadow banking system and now they're having the reforms of that and if you watch how that's being done it's being done smartly by by standards that let's say would be world-class standards as far as their capacity to deal with debt the debt is denominated in their own currency they can restructure data on could list all the four major as severe or worse debt crisis is that the united states has been through that i've been involved with in various ways i won't digress into that but there's a real basic question of debt and where they are in the debt cycle and what's their capacity the capacity to restructure a debt in local currency is almost unlimited we've done it many times and if you look at the general capacity to have a credit market and all that's associated with where their interest rates are i've commented before on there's monetary policy one two and three that you could use as markers of where you are in your debt cycle they still have their monetary policy one they still have the capacity to um use interest rates they coordinate fiscal monetary policy very well they have normal tools they have attractive capital markets and they offer an interest rate unreal and you're seeing the exchange rate benefit from that then there's monetary policy qe and the like and now we're in monetary policy three in which our particular credit markets and so on on and then our levels of indebtedness are uh so everything's comparative you know in investing that everything's comparative so if i line up their income statement and their balance sheet and so on certainly the power of the united states dollar as a reserve currency is a tremendous power that we're in a position of jeopardizing because it creates the means of the squeeze but the squeeze creates the changes and so you're seeing the development of new clearing systems and digital currency that will work in a certain way that would be a beneficial to their mmb and so on so if i take all of the financials their level of debt relative to ours their ability to handle it relative to our capacity to handle it all of those types of things where their interest rates are what the pricing the assets are where the listings are you're seeing a movement of the listings from new york they can say you're prohibited for listing but what that means for a practical investor is you know that if you want to participate then you'll be buying that stock and you'll boaster the hong kong and shanghai stock exchanges because the listings will be there and that will bolster that as a financial center so when i look at all of that and i'm looking at the finances i say what is not advantageous in that direction other than perhaps the politics but i i don't know that they don't win on the politics do i agree completely with ray on debt it's his area of expertise as well but i have been reading at least for 12 years now reports from various governments around the world about how chinese debt levels were about to chinese growth levels they've yet to materialize and the key point in ray's analysis is that practically none of it's internationally dominated but my point on the economy and growth prospects is not related to debt it's to do with the center of gravity on the political economy but raises pointed to in terms of i think a serious set of market-based reforms which the chinese have introduced to let's call it a credit allocation mindful of advice from people like rey saying the money's not getting true to the real economy that is the private sector it's going from five state-owned banks into a whole bunch of soes rather than filling the credit needs of the new burgeoning private sector now that has been a real area of market reform but when i look more broadly across the chinese economy in the last several years since about 2015 2016 the pace and direction of market-based economic reforms which xi jinping announced way back in 2013 by and large has not been implemented and there's a reason for it because in the internal debate within the system it goes back to some of the questions we've already discussed here today xi jinping is concerned about seeding too much political control to the chinese private sector it's now 60 of gdp private firms and the up there and the stratosphere like alibaba others you know the h a plus crowd if you like xi jinping has sent a message to the chinese political economy settings that i do not want this economy to become totally dominated by the private sector if you want evidence of that in the last two weeks alone the speech with xi jinping delivered to china's top entrepreneurial leadership about them needing to become members of china's international united front activities on behalf of the country and the party is more of a reigning in uh of let's call it the private entrepreneurial exuberance that we've seen over the previous decade now these companies are still going to grow my thesis is not that it's just therefore going to collapse but my thesis is that the economic growth level will now be sub-optimal because senior corporate private sector corporate leadership in china does not have the same level of unbridled confidence in the future that it had say prior to 2015 2016. nothing to do with covert so much not so much to do with the us-china trade war everything to do about the fact that the political economy settings are tilting more outside the finance reforms that ray's just referred to more in a state direction and less in a private sector direction i think that impacts long term on growth doesn't mean it stops growing but it won't be the same trajectory that we've become accustomed to ray and i will have a different view on that from a market perspective the prospect for capital controls poses a number of risks ray i wonder if you could discuss these risks and how we as investors should approach them i think you have to worry about capital controls in the united states over that time frame almost about as much as you would have to worry about capital controls in china so when you do the comparisons it's a challenge and i would say that one will need to think about capital controls more generally in the period um that's going to be coming ahead um and and i'm so i really think one should think about it in the united states and as well you even have to think about you know what is a reserve currency um we're used to something that is an extension of peaceful times and almost globalization and that's the globalization of trade and capital markets and so on and so forth i think you have to remember that the monetary s prior to 1945 the new monetary system we created a new monetary system that new monetary system prior when they had confrontation um nobody would trust each other's capital or money and there were plenty of capital controls and the way you would pay for things and we also have to think about you know what is uh what is a currency reserve i mean we're in a gap because um we're at the point where i think the u.s dollar is threatening its status as a world reserve currency but there are not good choices as a currency that's why we see other storeholds of wealth traditionally stocks are store all the wealth gold is the storehold of wealth and so on you're seeing movements um of that sort in that direction so when you look at the capital issue um it'll be a capital issue for uh you know possibly a number of countries and then let's say you step back and you look at investing in general it emphasizes the importance of diversification because you know you could look at china and with a bias toward thinking capital controls and so on or you could look at china and you could say the amount of foreign investment in china or the amount of holding of chinese financial assets as a financial investment is minuscule relative to the size of its economy or the size of its capital markets and you can look at the united states as saying um the holdings of other countries with uh dollar denominated uh assets and so on is enormous relative to the size of the american economy or even the size of its capital markets and then you look at diversification diversification is i think the main thing to pay attention to and you could say well you have um let's say technology is an important issue industries and so on and they're connected also whoever wins the technology race wins the military race too you know i'm in that whole thing and you say well where do you want to bet and it's really well how confident can you be in any bet you want to have i think uh proper diversification so that's how it looks to me in the capital markets and related to capital controls and related to all the issues pertaining to capital in the second session ray elaborated on the importance of diversification and how investors should position themselves the audio follows first of all i think it's so important to say like what are your market capitalizations why do you have them you know in other words how would you would you balance if you were just using expected return expected risk are you on for historical reasons but also don't make any necessarily good sense are you overly skewed in one place or another to take that look so i would say most portfolios are very very underweight in china relative to the united states or other countries but i would break countries now step back and i would say well there would be three levels of answering that question first the diversification question and second how attractive they are on the diversification question it seems to me that you could say every place is its industries that it's producing and it's p l so if you're looking for technology you're lo and big technology you're looking at the united states and you're looking at china and there's not much place going on elsewhere in the world in that kind of scale let's say but there are differences so i would say you also have to look at you know there's country diversification and there's currency diversification so i would say there's the united states and there's china and then there are those countries that are going to be immune from those things healthy countries that have good balance of payments situations and so on attractive markets and so on and so everything is on a relative basis so a look at your portfolio what is balance and why does it make sense and are there historical habits that have kept you that way secondly then there's these two countries which are leaders in uh those particular technologies you have to think of it as an industry by industry thing but let's say to to the extent that's a powerful influence not just on those technology companies but in their whole environments uh insurance like in penang in china that's important and then go to other countries that are not going to be involved in this that have strong balance sheets good income statements and civil populations kevin ray brought up the u.s dollar and the risk of losing its reserve currency status how do you assess that risk do you anticipate that the rmb will threaten the dollar status uh this debate has been ongoing for the last 20 years now from china's perspective what does it fear most in the world two things and perhaps three the u.s military the u.s dollar and u.s semiconductors probably in that order and the great thing about marxist-leninists is they tend to reduce things to ultimate equations of power and so that's kind of the the baseline of the analysis of what constitutes the elements of american power leaving aside all the other drivers of america's national economic and political circumstances today so the future of the currency therefore is right up there in terms of china's perceived sense of future global vulnerability so on the one hand the united states would china would dearly love to be free of any pressure in the future now that it would be placed under either through direct financial sanctions being placed on china through u.s through the u.s dollar or through economies using the us dollar for their international financial exchanges against china well secondly in the absence of hard and fast sanctions any other restrictions which begin to emerge in and around america's continued control of the global reserve currency so what has china sought to do in response to that a range of different things it's tried to introduce a whole range of renminbi currency swap arrangements with 20 or 30 countries around the world to use the renminbi as the currency of intermediation for bilateral trade between china and those countries the ultimate constraints still remain as follows china will be reluctant to fully liberalize its capital account and to fully liberalize therefore the convertibility of the rnb on open foreign exchange markets and the reason will be ultimately skeptical to do so reluctant to do so is that it does not want to place its um its politics in the hands of the of international financial markets where it perceives not an invisible hand at work but one giant american hand at work and that's ultimately the chinese constraint here so what might they do here is my view it's possibly an unpopular view but my personal view is as china's aggregate economic mass grows during the decade ahead analogous to the way in which it conceived of its military capabilities growing in relation to the united states as china's financial reserves and china's financial capacity to become itself a global investment powerhouse increases and rivals and exceeds that of the united states over time which is currently not the case then china when it believes that it is immune from any external currency market or capital market manipulation may well take the plunge to liberalize its currency as this decade of 2020's progresses i put that some time into the second half of the 2020s and i believe it is meshed closely in china's mind with scenarios that we've also discussed about what may happen in the taiwan straits and the risk of financial sanctions being imposed against china under those circumstances in other words how do you reduce and or eliminate your exposed u.s dollar-denominated financial sanctions at a time when you're going to accelerate geopolitical risk around the world by taking action against taiwan well in advance of that you immunize yourself by floating their rmb at a time when you believe the rmb will be of sufficient size and weight to dominate global capital markets irrespective of what markets may then conclude about the desirability of the rmb given the ultimate problem of the capacity of the chinese state to politically intervene in the value of the rmb on a given day and on the manner in which capital markets operate but i believe china may well be playing to a medium-term strategy based on aggregate size of its capital markets relative to those of the west then taking the risk to liberalize exchange rates in the capital account and then basically daring the rest of the world to take action against it using u.s boulder-denominated sanctions if and when national security scenarios arise later in the decade over taiwan in the second session to close i ask ray if the u.s dollar does weaken and it loses its reserve status what would that devaluation look like and what would it mean for investors the audio follows well in terms of magnitudes i look back at march 1933 devaluation i look back at the 1971 devaluation and those of the are of the dollar and then i look at other currency cases and so on it depends if it takes place in a conflicting you know like a war kind of environment if you take germany and japan for example in a war kind of environment which existed as a possibility that was a total wipeout of everything and and total debt so i would say the order of magnitude would be somewhere in the vicinity of 30 percent you know but there's a big range around the 30 to 40 percent but it has a cascading effect on a feedback loop that what happens is the united states is able to spend more than it earns from the rest of the world and we have built up all this ious and people are holding bonds and you're holding bonds and everybody's holding bonds in that thing if you lose that you start to lose that whole dynamic and then you almost you have to ask yourself history has shown you have enough of an exchange rate depreciation to bring the balance payments into equilibrium which means that you're now running surpluses and so you have to ask yourself when that happens what amount of extra output to the world are you going to give the world or what amount of cutting of your expenses are you going to give the world and what is the magnitude of decline if that were to happen it would be devastating politically because it means at a basic level that americans get to spend less in other words it's like budget controls or you have to raise your productivity level you can't raise your productivity i mean it's not you do what what you do with productivity and so it it represents a um you know the great decline the the end of the empire and all of that and it means a lot of political problems and all of that it is a very dangerous situation and we don't know if it'll happen but if you use the markers of it you'd have to say it's the biggest risk and it is a significant possibility so it's the thing that you would want to insure yourself against in some capacity that concludes this series on the future of u.s china relations thank you so much you

Channel: Bridgewater Associates

Views: 14,527

Keywords: Bridgewater Associates, US-China Relations, Ray Dalio, Kevin Rudd, David McCormick, Jim Haskel

Id: c84068o-smA

Length: 23min 22sec (1402 seconds)

Published: Tue Dec 15 2020