One nasty divorce, one reconciliation

Published 03.04.2017 23:23

This is been a critical week for financial markets as the two largest economies get together for the first time during the Trump presidency. Chinese Premier Xi Jinping will be President Trump's guest at his Florida resort, Mar-a-lago. His most important guest to be sure, Premier Xi will come ready to discuss many contentious issues with his American counterpart. Trump's trademark campaign speeches included jabs at China at nearly every turn so it will be interesting to see how things play out. Brexit has brought up sabre rattling between continental Europeans and the Brits over Gibraltar, signaling a messy split indeed. The fate of the pound and the euro depend on it.

"China." The word by itself may conjure images of endless natural beauty, exotic cuisines, a manufacturing behemoth, or the world's largest economy. When pronounced "Chi-Na," however, with a falling "Na" that is, the word brings back memories of President Trump and his China-bashing campaign speeches. The pronunciation of the word was enough to convey what Trump thought of the country, or at least pretended to think. No country took more of the brunt of Trump's protectionist speeches than China. Trump bashed China for its territorial "expansion" in the South China Sea. Trump bashed China for its "currency manipulation." Trump implied China was using North Korea as leverage against the "West." The list goes on and on. Now that he's president, the question is, what is he going to do about it?

Unfortunately for Trump, campaign speeches are much easier to navigate, especially for him, than summits and joint press conferences. Should Trump and Xi Jinping take questions following their summit, the first question will relate to what Trump has done about China's currency manipulation. It's true, China has guarded the fate of the yuan at every turn. Last year among a slide of the major Chinese equity indices, the Chinese government stepped into protect a falling yuan. Despite this move, the Chinese have traditionally continually devalued the yuan in order to keep manufacturing in the country attractive.

The issue of the islands in the South China Sea is a non-starter for both sides. While the Chinese contend the land is theirs to begin with and that expanding that land by filing in the sea around the islands is their right, the U.S. is worried a new Chinese naval base on the islands could be the first step in Chinese Jingoism meant to threaten America's Pacific allies. While the truth is probably somewhere in between, both countries have no moves to make. The U.S.-China relationship unlike the EU-U.K. is one in which interests are so intertwined, any surgery meant to separate the two would end up as an existential threat to both countries. Think of an immediate ban on all Chinese goods entering the United States. This would so incredibly cripple both economies overnight that getting along is really the only option for both. While it may be a death-blow to the Chinese at this stage, in a few years, it may not matter anymore as domestic demand may match the demand of American consumers. The term "in a few years" is really what is at issue here. A year ago, this may have been only one or two years ago, but the slide in Chinese financial markets exposed how vulnerable they really are and how China is not yet able to "go it alone."

While Trump may pressure China to "give up" currency manipulation, the truth is that that line is many years old. The Chinese are no longer devaluing their currency in fact they are probably propping it up. This makes Trump's words excite American manufacturing workers but the fact is, Chinese goods are so much cheaper than the U.S.'s that even with a free-floating currency, U.S. manufacturing jobs wouldn't return.

The most peculiar story of last week deals with the U.K.'s response to comments by the European Union that the fate of Gibraltar would be left up to the U.K. and Spain to discuss. This makes technical sense as Gibraltar is a part of the U.K. and Spain is its only neighbor making land travel impossible without a bilateral agreement between the two. At some point these comments morphed into the misperception that the EU and Spain wanted to annex Gibraltar. A few news cycles latter and U.K. politicians were reminding the Spanish about how they defended the Falkland Islands during Margaret Thatcher's tenure and how they would go to war to protect Gibraltar. Look for this story to be only the beginning of the nastiest of divorces.

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