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Trump, Clinton meet ‘Beijing put’

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Barron's Asia

The People’s Bank of China didn’t take to Twitter to troll Donald Trump and Hillary Clinton. It used an old-school reserve ratio cut to spite those critical of Beijing’s currency policies.

The yuan, make no mistake, is headed lower, not matter what Chinese officials said at the recent Group of 20 gathering in Shanghai. The only questions are magnitude, when and how? Does President Xi Jinping plan to engineer the 10 percent to 15 percent devaluation many expect all at once, or in drip, drip, drip fashion that roils them for months to come?

Yes, much to discuss at the annual National People’s Congress from Saturday to March 15. What should really worry Trump, Clinton and other U.S. presidential wannabes, though, is how Xi has decisively shifted from reform to stimulus mode. It means that China may, at least on paper, get close to this year’s 6.5 percent target, but it could imperil the global economy in 2017, when a President Clinton or a President Trump enters the oval office.

As I’ve argued before, China needs to recalibrate engines away from excessive investment and cheap exports to a services economy. That means reining in the credit arms race at state-owned banks, shadow lenders and local governments scrambling to help Xi make his numbers. Instead, Xi’s men are doubling down on greater stimulus and gearing up for the next leg of the global currency wars (perhaps later this month).

China has a reasonable argument to devalue, of course. As Barron’s argued in a Nov. 14 cover story, “Trump Is wrong on China,” the yuan is overvalued as growth sputters, exports drop and factories grow quiet. Beijing’s official factory gauge, for example, fell to 49 in February (below 50 means contraction). And wealthy Japan has been weakening the yen since 2012 with nary a peep out of the U.S. Treasury Department. Seen through this lens, central bank Gov. Zhou Xiaochuan cutting banks’ reserve ratio requirement by 50 basis points Monday makes eminent sense.

Yet it also suggests China is about to toss gasoline on an already raging blaze of volatility and panic. One immediate worry: devaluation accelerates the capital flight spooking markets and forcing Beijing to slash currency reserves — $100 billion in January alone. Another: a spate of defaults on dollar loans that snowball into a domestic credit crunch. And, of course, Beijing would invite a Trumpian assault on Twitter and other mediums. From Clinton, too, who recently declared: “We need to crack down on currency manipulation, which can be destructive for American workers.”

The real destruction, though, is China’s reform window. In recent months, investors buzzed about the “Zhou put,” a play on former Federal Reserve Alan Greenspan bailing out jittery markets with rate cuts via the “Greenspan put.” We’re now getting a glimpse of a broader “Beijing put” as Xi’s team does to the national economy what it tried to do in Shanghai last summer.

Beijing tossed everything it could think of at plunging stocks. Appearances and sage policy norms fell away as Xi’s men halted stock trading, scrapped initial public offerings, loosened every leverage tool, allowed day traders to put up homes for collateral and clamped down on bearish media reports. Troubling parallels are afoot in the broader economy, including media re-education edicts, censoring negative views on the growth outlook and demonizing those who dare to go off-script, including George Soros. Stories abound about data Beijing finds too revealing just up and disappearing.

Efforts to control the narrative don’t smack of strength in Beijing, but rising fear. Xi, it’s often argued, is the strongest Chinese leader in at least 25 years. That perception is negated by a government squandering so much time and energy shutting out the views of academics, talking heads and hedge fund managers a world away. Such paranoia and message micromanagement isn’t the stuff of a leader unleashing Adam Smith’s “market forces” on a $10 trillion economy. It’s amateur hour more in the orbit of Mahathir Mohamad, the former Malaysian leader who obsessed over Soros and his ilk at great cost to his nation’s reputation.

At the moment, the Beijing put is concerned with shoveling ever more credit into an already over-indebted and overcapacity-plagued state sector. While that means growth today, it also equates to more bad loans and a bigger crisis in the years ahead. Recently, China paved the way for domestic banks to issue almost $8 billion of securities backed by, get this, proceeds from nonperforming loans. Isn’t that pretty much what blew up the U.S. in 2008? Trying to out-subprime Wall Street hardly seems the way to go.

The next phase will be the weaker yuan Jack Lew hoped to avoid. If the U.S. Treasury chief thought he’d secured a Chinese promise to support exchange rates in Shanghai, the recent PBOC move should disavow him of such naivety. The same goes for International Monetary Fund head Christine Lagarde, who came away from the G-20 believing Beijing has “no intent” to let the yuan fall.

Then we could see a fiscal explosion that raises other risks. In a world of zero rates, deflation and panicky markets, the PBOC could just be pushing on a string. Beijing, at least on paper, has ample fiscal space. Officially, it runs a roughly 2 percent budget deficit as a ratio of gross domestic product, a far cry from Japan’s 7.7 percent.

Or does it? In January, Goldman Sachs explored Beijing’s broader, off-balance-sheet liabilities. As Barron’s Asia managing editor Robert Guy reported, Goldman puts China’s “augmented” deficit at a Japan-like 7.7 percent. But let’s say China is about to push its official ratio to the 4 percent range. If Xi fails to use the window afforded by monetary and fiscal injections, he’s just creating new bubbles on top of the $20 trillion credit boom since 2008.

Xi’s team could indeed use ramped up borrowing to broaden growth to the hinterlands and better balance the consumer demand mix. But that would necessitate a level of political will Xi has yet to display. His anti-corruption push, for example, smacks more of settling scores with rivals than a broad-based effort to cleanse the Communist Party. Xi’s reform efforts betray a similar air of short-termism — one that should worry Trump and Clinton.

While Shanghai’s markets are modest in size, the second-biggest economy is anything but. Rather than slam the Beijing put for weakening the yuan, U.S. candidates should be praying it averts a hard landing that trolls the winner’s presidency from day one.

William Pesek, executive editor of Barron’s Asia, writes on Asian economics, markets and politics.