…and our world will never be the same!
The North American Free Trade Agreement (NAFTA) is dead. Mexico and Canada have folded. A new agreement, the United States-Mexico-Canada Agreement (USMCA), will replace it. While the new agreement maintains the integrity of the North American market, it dramatically changes the rules and tilts the playing field in favor of the United States. In particular, changes in provisions regarding the percentage of North American content required in vehicles imported under the agreement, a mandate for huge increases in minimum wages in Mexico and support for labor unions in Mexico mean that an already resurging American manufacturing base is set to expand even more rapidly.
All eyes now shift to the ongoing trade war between the United States and China, the world’s two largest economies. Here the news is even better. We have already won.
Growth in China’s manufacturing sector stalled this September, with export orders falling faster than they have in two years. The Caixin/ Markit Manufacturing Purchasing Managers’ Index (PMI) for September fell more than expected to 50.0 from 50.6 in August. The index measures the rate of expansion or contraction in an economy, and the neutral 50-mark divides expansion from contraction. What was once the world’s fastest growing economy, destined to overtake the United States at any moment, is now poised, not simply to cool off, but to begin to shrink in size. New export orders from Chinese firms, the all-important indicator of what the future portends, are now shrinking across the board.
“Expansion across the manufacturing sector weakened in September, as exports increasingly dragged down performance and continued softening demand began to have an impact on companies’ production,” said Zhengsheng Zhong, director of macroeconomic analysis at CEBM Group, a company specializing in analysis of the Chinese economy. “Downward pressure on China’s economy was significant,” said Zhong.
China’s currency is in free fall. China’s foreign exchange reserves fell more than expected in September 2018 to a 14-month low as the yuan weakened against the dollar.
China’s stock market is crashing. It has lost $2 trillion in value already this year. China, which overtook Japan as the second largest stock market in the world only a few years ago, has now officially fallen behind Japan. The losses show no signs of abating.
Chinese investments in the US plummeted 92 per cent in the first nine months of 2018 from their peak two years ago. In New York, where Chinese money was once driving real estate prices through the roof, the Chinese are now selling and going home. In the second quarter of 2018 Chinese investors sold $1.29 billion worth of US commercial real estate. During the same time period, Chinese investors bought only $126.2 million of property, according to data firm Real Capital Analytics. This marked the first time that these investors were net sellers since 2008.
Meanwhile, back home, China is on pace for a record year in corporate-bond defaults. Chinese companies have reneged on about $2.5 billion of public bond payments so far this year. As the economy downshifts and the threat of US tariffs hangs over everything, Chinese companies increasingly simply cannot pay their debt.
“Corporate profits have worsened this year and are unlikely to improve against the backdrop of an economic slowdown,” said Li Shi, general manager of the rating and bond-research department at China Chengxin International Credit Rating Company.
Meanwhile a spokesman for the Chinese Supreme People’s Court is warning of an impending flood of Chinese bankruptcies and telling the Chinese judiciary to prepare in advance.
“It’s hard to predict how this trade war will develop and to what extent,” the spokesman said. “But one thing is sure: if the US imposes tariffs on Chinese imports following an order of US$60 billion, US$200 billion, or even US$500 billion, many Chinese companies will go bankrupt.”
Against this backdrop China-based manufacturers, many of whom were already in the process of moving out, have intensified the speed with which they are leaving.
“Companies aren’t as eager to have production in China,” says Nathan Resnick, CEO of startup company Sourcify.
“We run production runs in India, Bangladesh, Vietnam, Philippines and Mexico right now. Labor costs are actually more affordable outside of China, so for products like apparel where there is a lot of cut-and-sew labor, most companies are moving out of China anyway,” he says.
“I’ve been going back and forth to China for years, and it is getting more expensive. With all these tariffs coming, why not run some of your production runs elsewhere? Companies are saying that the scare of these tariffs has decreased the incentives to manufacture in China.”
Discussing the trend, William Ma Wing-kai, managing director of Kerry Logistics Network, a Hong Kong-listed firm owned by Malaysia’s billionaire Kuok family, stated,
“Our clients have been shifting part of their production lines as early as March from China to other Asian countries where they already have manufacturing plants. This is a reallocation of global production bases.”
In retrospect none of this should come as a surprise. The result of this confrontation was preordained. The United States is far and away the world’s largest market for consumer goods. China, which lives or dies based on exports cannot lose access to the American market and even begin to replace those sales elsewhere. There are on the other hand an almost endless number of other locations other than China, including the United States, to which manufacturers can move their factories and shift production. China was already seeing the beginnings of this shift before the trade war began. The confrontation with the United States simply intensified the trend.
What comes next will reshape the global economy and the world’s geopolitical landscape. China will ultimately cave and sign a deal. Its economy will not collapse. It will, however, never again see growth on the scale it has seen for the last thirty years. Within a year or two, in fact, we are likely to see a red-hot American economy surge past China in its rate of growth. China, which once thought fit to challenge the United States for global supremacy will remain a second-tier power.
Chinese influence around the world, heavily dependent on the availability of funds to invest, will decline precipitously. Chinese plans for massive defense spending will be still born. Outposts in the South China Sea once taken as harbingers of relentless expansion will instead stand as high-water marks for a nation facing the harsh reality of economic contraction.
The ultimate reckoning will come inside China however. Ever since China opened its economy to the world it has had an implicit bargain with its citizens. They would accept continued authoritarian rule by the Communist Party in exchange for a rising standard of living and greater economic opportunity. The Communist Party is about to be forced to admit that it can no longer keep its end of that bargain. What the people do next remains to be seen.