China's MFG Weakens as Geopolitical Realities Settle In

The first of the realities to sink in is that wishing does not make it so... despite an all-out charm offensive by Donald Trump he could not coax Kim Jong Un over from the dark side of the farce. Trump still has his charm offensive aimed and Chinese premier Xi but in testimony this weak the US trade negotiator Robert Lighthizer made it clear that the US is not having a love-fest with China and that the back and forth is more like that of dentist battling the removal of an impacted molar.

China has not said 'uncle' and given into US demands - far from it. China is only reluctantly making the sorts of concessions that the US demands and that real free trade requires. China is trying to tilt the playing surface by putting agriculture on the table something they need and that will find little competition in China. But the US seeks inroads, protections and purchasing ‘goals' on manufactured products and China has been moved in this direction only at a glacial pace. Lighthizer has warned that any China deal will have to have teeth and lasting goals and arrangements for repercussions if China does not perform and deliver on its negotiated promises. For this reason the US needs to negotiate some very specific things so there can be a test against what China delivers. There will be no ‘gentleman's handshake.'

In contrast Mr. Trump has said that a deal is very, very close. Maybe this is a negotiating tactic meant to encourage more bargaining than an unenlightened view of the proceedings. Lighthizer, who does not see the negotiating reality this way, is afraid that after all the back and forth Trump will be too eager for a deal and will rollover for a lesser trade agreement that will not really deliver. Trumps willingness to walk out on North Korea and a bad deal may put a fresh perspective on such concerns and may also light a new fire under Chinese feet. Trump is not Obama he is not a negotiating push-over.

Maybe Trump's willingness to walk away from KJU will ally some of those concerns. Maybe his willingness to walk away also sends a message that he is not captive to getting a deal, any deal. Based on what we heard about what N Korea wanted it (or thought it could steal…) it appears as though they thought they had Trump over a barrel. Trump's willingness to walk away from a truly bad deal should send a strong message to N Korea and possibly also to China on trade negotiations. With China the stakes are somewhat more immediate if not higher (trade is important but it's hard to get stakes higher than eliminating nuclear weapons after all) as China faces a tariff bump up to 25% if these talks fail something it clearly wants to avoid.

The chart above shows that manufacturing in the US is weakening, in EMU it is weakening, and in China is weakening in terms of their respective PMI indices. And it is also clear that the US is still doing the best among these three and that while EMU is weakening the most sharply it is China where actual conditions currently are the weakest. That puts the US in the cat-bird's seat for negotiating.

The China Federation of Logistics and Purchasing survey shows a headline PMI that is weakening; it below 50 and averages under 50 over the last six months. In February all the index components except input prices (value = 51.9) are below the 50 threshold indicating contraction on those gauges. The PMI headlines show net declines over 3-months, 6-months and 12-months With 8 of 11 components each showing the same stepwise deterioration. In short China faces a great deal of weakness and some very broad-based weakness.

If we rank the headline PMI as well as its components we get another angle on this weakness. Since 2005 the headline has been this weak or weaker only 6.4% of the time. All components are below a queue ranking on this time line of 50, which puts them below their respective medians. And only four components have readings as high and their 20th to 39th queue percentile range, these are delivery times, new orders, stocks of finished goods and input prices. All the rest of the components have queue standings that demonstrate that they have been weaker less than 10% of the time.

Negotiating with China

I continue to argue that China is more at risk than the US in these negotiations. If tariffs go higher and if they spread to other goods as well consumers can react to tariffs by switching expenditures. We are no longer in the Middle Ages and importing only essential merchandise. There are a lot of purely discretionary goods that the US imports and that consumers can choose to buy or not. Maybe they will opt for more travel instead of buying a new, more expensive, cell phone or tablet. It's not clear how long tariffs might remain in place so I would not expect much of an immediate supply response in the US but there could be some on the margin. In contrast China needs to produce AND SELL goods to employ its people, to support growth that already is weakening. If US consumers take an oh-hum attitude and avoid higher prices on tariff-distorted Chinese prices and merchandise, China will suffer more. China already has set aside its program of debt reduction to ramp up debt to support troubled domestic firms and sustain growth that is nonetheless flagging.

China knows that it must develop more domestic demand and rely less on exporting. But Xi's belt and road program is geared to support and enhance China's manufacturing and to promote traditional Chinese advantages in goods trade as long as possible. China is not making the shift to developing domestic demand even as it became clear that it must do that in the wake of the Great Recession and financial crisis. Just that now several Chinese projects notably one is Sri Lanka and a power plant in Ecuador have gone so badly that other nations are rethinking whether China's ‘help' is all that helpful after all. Malaysia has cancelled two major China projects, a rail project and a pipeline project, on the fear that they could bankrupt it. So much for China being ‘helpful.'

No discussion of China could be complete without mentioning that it grabbed the South China Sea with no legitimacy and had its ‘claim' rejected by the world court whose ruling China has ignored and rejected. This, more clearly than anything else, reveals what it is we are dealing with when we deal with China. We have leverage on China only so long as we have something it needs. The minute we lose that leverage we lose the ability to sway China, a country that has never shown a tendency to do do the right thing simply because it was the right thing to do.

Everything China does is for its own advancement or to diminish a foe. China is relentless. And so in negotiating with China we too must be relentless and willing to fight – hopefully I mean this only diplomatically and in in terms of hard bargaining- for what we believe in. And…China has been no help on the issue of North Korea.

Globally growth is weak

The table above goes beyond MFG PMI data to asses GDP growth through 2018 Q4. Red figures in the table flag period to period slowdowns. Note that the table is awash in red. That is except for the quarter-to-quarter portion of the table to left (Quarter over quarter – Saar). In terms of quarterly growth data in 2018-Q4 only Italy, the UK, and US decelerated quarter-to-quarter (on annualized rates of growth) while very other entry in the table accelerated. Still, the median growth rate among EMU reporters (8) is only 1.3% (annualized!). US growth though slower month-to-month is at 2.7% in Q4 down from 3.4% in Q3, a pace unmatched by any other country in the table. At the far right we rank each nation's current year-on-year growth rate since 1997 and find that of 13 countries/regions only FOUR have growth rates above their historic medians for this period (…that have queue rankings above 50%). Finland, the Netherlands and Portugal are three of these countries with rankings ranging from 52.2% to 59.4% - all still in the 50 percentile decile range (50% to 59.9%). In contrast the final above average growth country is the US with growth in its 87.5th percentile- quite robust. Remember that that these are time-series comparisons not cross section. That means we are comparing each country to its own history not to the histories of other countries.

Summing up On balance, we see a good deal of weakness globally. We have a sneaking suspicion that US-China talks are still more in the trenches with the troops than about to create flowery language from the lips of diplomats. In any even we await the result and can be ‘heartened' that Trump is the negotiator he says he is - he is not giving in to a bad deal and that could help his odds of getting a good deal in China. China's economy is weak and slowing and digging deeply into debt adding to a huge stockpile of debt to support its growth. It desperately needs to cement access to its most important export market, the US. The problem is that it does not want to cement access on the terms that the US in demanding. This puts China Vis-a-Vis the US a little bit in the same position as the UK Vis-a-Vis the EU. Nether wants to break off with no deal but neither China nor the UK wants to accept the deal that is on the table. And time is running out. The UK faces a deal that is more clearly clay (already set) than putty (malleable) while for China its deal is still putty and fully malleable it's just that China does not get to sculpt the deal that it wants. So that saga churns on.