Weekly Economic Update

Michael Drury, Chief Economist

Volume 85, Number 11 March 23, 2018

China’s National People’s Congress ended this week -- and a lot has changed. Most widely touted was the removal of term limits on core leader, and now possibly President for Life, . As important was the return of 69 year old , former head of the Party’s corruption campaign, as Vice-President. This duo will lead a new slimmer Chinese state government as many cabinet level ministries were reshuffled to eliminate overlaps in responsibility and consolidate more power in the central government. Moreover, Xi Jinping’s Party First philosophy is now ingrained in the Chinese constitution. To ensure this, the National Supervisory Commission was created as a new branch of government dedicated to enforcing the Party’s primacy in all phases of Chinese life. For better or worse, all China is now marching in a single unambiguous direction dictated by Xi – with eliminating poverty, reducing pollution and curbing financial risk as the immediate goals. With a stronger than expected start to 2018, early progress seems assured – unless a simmering trade war escalates beyond the US floating trial balloons as electioneering dominates ahead of our midterms.

That Xi Jinping (now 64) and his long-time friend Wang Qishan will lead China during its rejuvenation as a world power has never been in doubt to the local audience. Eliminating the Presidential term limit was a pragmatic step which removed any possibility of Xi being a lame duck. There is no term limit on his more important positions as Secretary General of the Party and head of the Central Military Commission (think Commander in Chief). Even the retirement age for Party positions is flexible as Jiang retired as Secretary General at 76 and from the CMC at 78. State positions, like Vice President, also have a flexible retirement policy as shown by Zhao Xiaochuan, the longtime (until recently retired) head of the central bank. Bottom line, Xi and Wang will likely be around for a lot more than 10 years, not unlike Putin -- or Merkel. Unlike those two, there is no current domestic disgruntlement with either China’s executive leadership or the Party’s control. China looks set for another year of “on target” 6.5% growth. From our point of view, it is bottoming on the real estate roller coaster ride with renewed growth more likely than ever in 2019 and headed into the Party centenary in 2021. The only flies in the ointment are Trump’s rattling of the trade sword – and far more important to the Chinese, poking the dragon about US-Taiwan relations. Xi’s revamping of China’s state government mirrors the earlier restructuring of the military, where the goal was to eliminate competing power bases and consolidate power under Party (rather than military) leadership. The state plan reduces the influence of the National Development and Reform Commission (NDRC) -- often called the “small cabinet”—which exercised substantial control as the command center for economic planning. Now many responsibilities will be distributed to various cabinet level branches – each with a clearer responsibility to carry out their mission: high speed rail is now under Transport; the new Ministry of Natural Resources decides development zones (headed by Lu Hao, China’s youngest minister, the youngest Vice-Mayor of under Wang Qishan); Agriculture is expanded to include rural investment; the much broader National Health Commission replaces the family planning commission; etc…. Every state ministry is now more fully responsible for achieving its Party set goals -- and with no finger-pointing at others concerning failure to deliver.

Meanwhile, the former will no longer report to the State Council (the cabinet under Premier ), as the new National Supervisory Commission will report directly to the Party, through the Standing Committee’s Zhou Leji, who replaced Wang Qishan as Secretary of the Central Commission for Discipline Inspection (CCDI). The NSC will expand the CCDI’s corruption campaign beyond Party members to include all public workers. Created in the Constitution, the NDC is separate from the Courts, with its own laws -- similar to the military. The NSC will be led by , formerly from the CCDI and a close associate of Xi’s. Meanwhile former CCDI Deputy Secretary takes the role of Procurator General (think Attorney General) reporting directly to the President, not the Premier. Two more CCDI alumni will head the Ministry of State Security and the Ministry of Civil Affairs. Do you sense a pattern here?

Beyond Party control, the foreign sector, economics and defense also appear to be stepped up under the new government. China’s top diplomat, was added to the Politburo in October. Now Foreign Minister will retain that title while simultaneously serving as State Councilor (one step below Vice premier). To broadcast China’s view to the world, a new Voice of China will combine CCTV, & China Radio International under the Propaganda Department. All state run news, like the trial balloon about US soybean subsidies just issued by the , must be interpreted as thoroughly vetted and approved by the state. China truly speaks with one voice.

China’s new economics team will be led by Xi’s closest advisor and new Vice-Premier, , a Harvard educated economist who recently visited the US to a cool reception. It is probable that VP Wang, long the fireman of Chinese politics, will be recruited to help manage this blaze as well. Liu will be working with new Central Bank President Yi Wang, for 10 years Zhao’s #2 and a University of Illinois Ph.D. Meanwhile, China’s attack on debt and financial risk intensifies as CEFC (a large quickly built private oil fund and conglomerate with deep Czech ties) becomes the latest firm to face breakup and an unwinding of foreign positions, which include $9 billion of Rosneft. China will merge its bank and insurance regulators (leaving stocks separate) as it seeks to reduce the risk created by too much leveraged lending due to cheap and readily available government credit. The new Defense Minister, , is also a new State Councilor. He was an early adherent to Xi’s plan to restructure the military. At that time, though he was head of the Second Artillery Corp, he proactively provided Xi with a plan to split it apart, and was subsequently appointed to lead the new, but smaller, Rocket Corp. Bottom line, in Xi’s world loyalty is rewarded.

The new state and Party leadership in China thrives on an unusually high level of professionalism – especially when compared to the corrupt era that preceded. This is in large part a result of the unique Class of 1977. Following the Cultural Revolution, the national exam for college admission was reinstated in late 1977, after a 12 year drought during which very limited college admission was by recommendation largely by local party bosses. Nearly 6 million vied for 273,000 slots (with another 6 million trying for slightly more seats in spring 1978). The entering class had students who were 16 to 36; some just children and some with full grown families; some straight from high school and many from labor as sent down youth. The winners have long been seen as the elite of the elite in China. The breadth of their classes – especially at top universities -- created golden rolodexes which helped many advance far in life. Premier Li Keqiang was a student at Peking University, as were Bo Xilai, Wang Juntao (one of the Black Hands responsible for the Tiananmen riots) – and my late colleague, Arthur Yang. Liu He was from this class, as were 90 of the 18th National Congress and even more in the new 19th. Currently, only 11 of the 205 full members of the 19th Congress were born before Xi – and five are Politburo members. Only 20% were born after 1960 (too young for the class of 1977). With this group in power, maybe there is a good reason to scrap the retirement age.

The US-China trade war escalated this week – sparking a sharp selloff in US equity markets. To protect US intellectual property, the US wants 25% tariffs on $50 billion of Chinese goods, (to be named in two weeks and then have 30 days for public comment.) And, Treasury Secretary Mnuchin has 60 days to institute limits on China’s US investments. Also, replacing Secretary of State Tillerson with CIA Director Pompeo, and National Security Advisor McMaster with Bolton signals a more confrontational stance. Yet, the most important Sino-US measure may have been the March 16 signing of the Taiwan Travel Act, which allows US high ranking officials to meet with counterparts from Taiwan. For China, this is not a trade tactic – it is about sovereignty, as with Russia in the Crimea.

China responded to the steel and aluminum tariffs (from which many are now excluded) with proposed tariffs on 128 US goods worth $3 billion including aluminum, steel, fruits, wine, nuts, and pork. The timing and delays implicit in these announcements show the game theory involved in these negotiations – as we saw with NAFTA members on the metals tariffs. The Chinese answered actual tariffs, as on solar panels and washing machines, with actual tariffs on sorghum. They responded to actual proposals with their own proposals. They don’t react to trial balloons in the press at all. But the Taiwan Travel Act drew a sharp rebuke from Xi himself at the close of the National Congress – and the Global Times (which floated the soybean story) has opined about when China will take Taiwan by force. The tariff war is still small beer, especially when compared to the earlier US stimulus – but rattling an actual war sabre, even if well received at home, may be far more risky. Asia is already in an arms race. North Korea is still a rogue agent. And Xi, unlike Trump, does not face re-election. For a chance to meet and learn from Michael Drury as well as other financial luminaries during Financial Literacy Day 2018, please visit www.Interdepence.org for registration and an agenda.