The Week in Review  30 Nov 2018

11 months have now passed for 2018 and global markets have had a hard time.  Most equity markets, bond markets and commodities are in the red for now, and the Trade Wars have caused a significant repricing of risk across asset classes.

Having called the end of the 2009 – 2018 Bull market, we see the first leg down to be over and last week sharp rebound in equity markets to start a significant year-end rally.

The Nov 30 G20 meeting in Buenos Aires is significant as Trump and Xi met to pause the Trade Wars, Putin and Bin Salman agreed to continue supporting Oil prices, Canada, Mexico and the US signed a new NAFTA Agreement and the G20 agreed to reform the WTO.

Meanwhile, Emmanuel MACRON’s drive to reform France is hitting the snag of France’s love affair with revolutions. 

Trade Wars

China and the United States agreed to a ceasefire in their bitter trade war on Saturday after high-stakes talks in Argentina between U.S. President Donald Trump and Chinese President Xi Jinping, including no escalated tariffs on Jan. 1. 

Trump will leave tariffs on $200 billion worth of Chinese imports at 10 percent at the beginning of the new year, agreeing to not raise them to 25 percent “at this time”, the White House said in a statement. 

“China will agree to purchase a not yet agreed upon, but very substantial, amount of agricultural, energy, industrial, and other product from the United States to reduce the trade imbalance between our two countries,” it said. 

The two leaders also agreed to immediately start talks on structural changes with respect to forced technology transfers, intellectual property protection, non-tariff barriers, cyber intrusions and cyber theft, services and agriculture, the White House said. 

Both countries agreed they will try to have this “transaction” completed within the next 90 days, but if this does not happen then the 10 percent tariffs will be raised to 25 percent, it added. 

The Chinese government’s top diplomat, State Councillor Wang Yi, said the negotiations were conducted in a “friendly and candid atmosphere”. 

“The two presidents agreed that the two sides can and must get bilateral relations right,” Wang told reporters, adding they agreed to further exchanges at appropriate times.  

“Discussion on economic and trade issues was very positive and constructive. The two heads of state reached consensus to halt the mutual increase of new tariffs,” Wang said.  

“China is willing to increase imports in accordance with the needs of its domestic market and the people’s needs, including marketable products from the United States, to gradually ease the imbalance in two-way trade.” 

“The two sides agreed to mutually open their markets, and as China advances a new round of reforms, the United States’ legitimate concerns can be progressively resolved.” 

The two sides would “step up negotiations” toward full elimination of all additional tariffs, Wang said. 

The announcements came after Trump and Xi sat down with their aides for a working dinner at the end of a two-day gathering of world leaders in Buenos Aires, their dispute having unnerved global financial markets and weighed on the world economy. 

After the 2-1/2 hour meeting, White House chief economist Larry Kudlow told reporters the talks went “very well,” but offered no specifics as he boarded Air Force One headed home to Washington with Trump. 

With the United States and China clashing over commerce, financial markets will take their lead from the results of the talks next week, widely seen as the most important meeting of U.S. and Chinese leaders in years.

Rising Powers and Competing economies

America’s economic tussles with China go way beyond trade and are all too reminiscent of the rivalry at the beginning of the last century between Britain, the superpower, and the rising power, Germany, which led to the First World War.

And many voices in the US today see China’s rise as a cause for military conflict, however the real risk is much more one of an economic iron curtain dividing the world’s two biggest economies.

For all the worries about “Thucydides’s trap” (the phrase coined by Harvard’s Graham Allison to describe the depressingly frequent record of conflict whenever an established superpower is challenged by a rising one), some historians think one feature of the First World War was its avoidability. 

There was no set course that led inevitably from an Austrian archduke being assassinated in Sarajevo on June 28, 1914, to millions dying in the trenches. 

No country can learn more from looking back than China. 

The Chinese are fixated by history, and they read books. For instance, Wang Qishan, China’s vice president, will happily discuss Alexis de Tocqueville, Stefan Zweig and the Hundred Years’ War. As we highlighted in many of our post about China, the world would make a mistake to underestimate the credentials and experience of the Chinese leaders that are currently in power. 

But there is also a practical reason for China especially to look back. In the lead-up to World War I, every European power made mistakes, but if any one country was a little more culpable than the others, it was possibly Germany. 

The rising power never understood the consequences of its militarism, never grasped the resentment its economic rise was causing, and found
itself short of friends.

China stands a much better chance of rising peacefully if it has the world by
its side and this is how it has positioned itself until now in this trade war.

Donald Trump championed America First, China used it to champion multilateralism and increase its hold and cooperations in Asia, the growth engine of the world.

Another lesson form History is that China has always been reluctant to expand its wings militarily. Their country is so vast and populated that dealing with internal Peace and economic development has always been the priority, even at the time where China’s empire had technologies and resources that way surpassed the nascent European powers.

 China today has to juggle with a world integration and the need to fulfill its domestic priorities.  

It even goes further than that as, as we have highlighted in our post AMERICA HATES CHINA, SELL AMERICA AND BUY CHINA, the Chinese political system is not very well understood in the west but will ultimately prove to be more efficient economically – if not democratically n the Western sense of the World – than the free-wheeling capitalist system of America.

China’s political organisation is inspired by the West’s corporate organization which has proved its efficiency while the Western democracies still have their leaders elected by their clients instead of being chosen by a competent Board of Directors,  

The net result is massive swings in course of actions, inability to plan for the long term and the rise of populism as Western Leaders are all about marketing and very little about results.

This global confrontation is systemic as much as economic and the transition of world dominance from the USA to China will also infer a shift in global Public Governance.


China’s biggest handicap is its cultural inability to admit that it has done anything wrong.

China’s culture is one of community not individuality and taking individual responsibility for mistakes usually comes with a millenar tradition of punishment.

It is highly likely that this will fade away with the new generations that are all on the Social Media and elites that have been groomed in the best Western Universities but it is still very prevalent with the current generation in power/

On issues like intellectual property and contractual obligations this has always been a problem. 

Chinese officials seem perplexed: Why haven’t American companies rushed to defend the multilateral trading system against Trump’s rampages? 

The answer is fairly simple: Western CEOs are privately fed up with the way China treats them, the artificial barriers, the ownership restrictions, the
intellectual property theft and the repeated delays in opening up markets.

This is not to say that China does not realize it has to open up its markets or respect international laws. It just takes more time in China to get through the system because of the cultural difference and the need for consensus than the West would like.

Moreover, China is not 100 % sure that the right model is the American Model, not only for its society but for the world at large.

What Americans do not realize is that their country, seen from the outside world is not a resounding success.  It boast the largest social inequalities, provides no economic safety net, has the largest proportion of poor people of any industrialized nation, the largest proportion of their population behind bars and it has random shootings every other week for no reason other than people like to carry guns.  Americans are highly indebted, their countries highly indebted and their infrastructure now becoming derelict. 

The good news though is that China full knows that opening up its
economy is in its own interest.

Earlier this month Xi promised to import $30 trillion worth of goods and he re-iterated it to day in Buenos Aires.. And China has promised to push ahead much more quickly with opening up industries, including financial services.

Of course, China has muttered about opening up before and done very little, but there is a difference now. 

China’s economy is in transition. The next phase of its growth, officials say,
will come from services and personal consumption. It would much rather suck in foreign capital than add yet more debt and government stimulus. 

And to do that it needs to do to things, open up its capital markets and allow its currency to rise.

We are reaching that point now.  The Trade Surplus of China is Structural in nature and not only with the USA.  

China needs to have the courage to allow its currency to rise to increase the purchasing power of its citizens. 

Surely, it worries about the impact of a currency appreciation on its exports, but then it needs to re-balance the terms of Trade for its development to be balanced 

Dec. 18, 2018  is the 40th anniversary of the third plenary session of the 11th Central Committee of the Communist Party of China, which was the moment in 1978 Deng Xiaoping started opening up China’s economy. 

Xi is likely to take this occasion to unveil a series of commemorative reforms; foreign banks that have been waiting to take bigger stakes in their Chinese joint ventures may well find the approval process is speeded up. and a formal announcement that the next strategic orientation is a stronger Yuan.


The problem  is that China is one of the relatively few areas where Trump has strong and consistent views. 

An America-Firster to his core, he has no intention of letting China become the world’s biggest economy. He is surrounded by people who think China has cheated America — notably his vice president, Mike Pence; his economic advisers Robert Lighthizer and Peter Navarro; and his national
security adviser, John Bolton. 

And he thinks he has American public opinion behind him, especially on the issue of intellectual property at the heart of the current dispute.

Under this scenario, Trump may have given Xi a small concession in Buenos Aires — delaying the 20 % planned tariffs for now — but he is likely to keep bashing China until it gives in.

The main limitation to Donald Trump’s China bashing is his own stock market end economy.  October showed that Trade Wars did not go well with the financial markets and that chain reactions are easy to create but difficult to contain.

So the Chinese will need to be very patient.  The rising power that waits is the one that probably wins.

Emmanuel Macron and France’s Revolutions

For several weeks now France has been embattled in one of its regular burst of public discontent and scenes of city ramps are becoming current every Saturday.   

Yesterday’s images go the Arc de Triomphe – the well named iconic symbol of France’s political might – being surrounded by fires and tagged by demonstrators out of control have gone around the world and shocked viewers in France and elsewhere.

Such scenes have never been seen in any other European countries and the French have a cultural tradition of the revolution.  They are the only people of the world that considers that the 1789 French Revolution was a great success and that Revolutions are ways to move forward, despite their horrendous costs to society.

The World watches France with two questions in mind :  How come a totally unplanned movement such as ” Gilets Jaunes” could erupt and how come te French institutions could not contain it, leading to these scenes of destruction and chaos.

The answer to both questions lies in one single specificity of the French Political organisation and Public Service tradition.

Starting with the first one, the general feeling of discontent in France comes from a multi-decade long failure of the French system to ensure prosperity for its people.

France is one of the very few countries in the world where te public sector still represents more than 50 % of GDP and the France post WW2 has been built on this tradition of the State Supremo at the expense of free enterprise, fair taxation and economic growth.

The French Political culture, inherited form the Kings and Emperors is that the State is in charge of everything instead of just being there to facilitate economic activity and preserve order and justice.

In France, and entire class of Civil Servants, all graduating form the same Ecole National d’Administration have replaced the autocratic powers of Monarchy by and autocratic powers of meritocracy.

These people, who have never worked in the Private Sector and always had a lifetime guarantee of employment do not understand the free forces of capitalism and rule everything by adding constraining laws and regulations.

For the decades following WW2, the French economy and society has been constrained by a dirigist State leaving it with a bloated public service, tremendous rigidities in the labor market, massive and unfair taxation of Labor and deficient Social security and retirement systems.

France has a massive structural unemployment rate at 9 % of its workforce and taxation and rigid labor laws prevent investments.

Problems are solved by creating more rules, more subsidies and targeted measures which make business life complex and the corps of Laws inextricable.

When you start a company in France, the very first thing you do is pay an amount to URSSAF, the social security organism, even before you have made one singe Euro.

The French population, country to many Western Europe populations is in survival mode with their ban accounts in debit at the end of the month.  

But interestingly enough, they are all determined to fight for their privileges even if these privileges  run against the efficiency of the country and the economy, the best examples being SNCF, the National railway Company, Air France, the public eductaion system or the civil servants.

The regular switch between the traditional left and the tradition right did not change anything as the people in charge in both camps all came from the same school, with the same frame of mind and the same inability to reform the system that was put in place.

Until Emmanuel MACRON came to power in 2017 with a reform agenda.

And indeed, the amount of work done in barely 18 months is commendable considering the paralysis of the previous administrations.  He has reformed the tax laws, the labor laws, the statuts of the National railway company and is targeting the organization the Civil Service.

However, France is a country that is difficult to reform. 

Many times in the past, in May 1968,  in 1995 with Alain Juppé or later on with Lionel Jospin, the French took to the streets when Governments tried to reform the system. It is cultural and as long as they are encouraged to do so, they rev up the movements.

The most striking feature of Today’s France unrest is that 80 % of the population sides with the “Gilets Jaunes’ despite the high economic cost of their paralysis of the country.

And the whole construction of the Civil Service around Lifetime employment and privileges made it even more difficult as politicians had to fight for reforms not only with the People but with their own staff inside the administrations.

Emmanuel Macron high speed pace of reforms was bound to be difficult to accept for the French and his regains personal style did not help, making him the French president with the lowest approval rating in the recent history of France at this stage of a Prudential Mandate.

Moreover, Emmanuel Macron is not a new Breed of politicians.  He comes from the same school and is surrounded by the same type of advisors who are all former Socialists Enarque who have re-converted into La Republique En Marche. his newly created political movement.

Macron is seen as favoring the rich and taxing the elder while taking away the privileges of the lower classes.

His entourage and his Government are still dealing with social unrest with the fears of those highly protected civil servants who prefer to yield-in rather than set the right priorities such as making the law respected and using force to prevent social unrest.

Emmanuel MACRON may also have made another mistake.  By surrounding himself by and getting elected young and un-experimented Members of Parliament he is now lacking the political support from people who have a say on the ground and can act as relays to explain his policies and needs for reform

France is waking up in shock on December 1st 2018 and Emmanuel MACRON has a huge task on his hand :

Re-establish law and order, open negotiations, give-in on certain things and go even more strongly on his program of reforms.

Frances’ ultimate problem is the size of its public service and unbearable weight of the state on its economy.

Macron must keep the pace of reform and manage discontent at the same time.

He will be weakened by the upcoming European elections where his political formation stands to be defeated, but luckily fr him, there is not much in the political landscape to provide an alternative

The Markets in Review

Currencies

The US dollar ended the week marginally higher against all currencies but after a sharp and volatile trend-ending swing on Thursday.

We expect the US currency to depreciate against the EUR and most emerging currencies from here.

Equities

Equity markets rose 3 % on average last week with the US markets up by 5 %. Japan, Asia and Europe followed suit while China was holding its breath for the G20 meeting.   Technically, all markets are bound to go higher next week and 2018 could end up being a good year in equities.

Commodities

Oil is trying to find a floor at 50 but the picture is globally unconvincing. Gold and Silver remain hostage of the fate of the US dollar and metals were mixed.

Bonds

Greek bonda and corporate credits did very well last week as thee worries about Greece are fading away and investors are re-assured about the pace of interest rates in the USA.  Still, we don’t see much value in fixed rate bonds apart from corporate bonds.