Events Friday appeared to be dominated by the release of Q3 Chinese GDP data, which came at 9.8, above the expectation of 9.4-9.6 current in the market. Inflation is reported to have eased to 4.6% in December, but that will provide no change to the government`s assessment of the current situation, and the need for rate increases, since price pressures in the commodity market, and the domestic sector leave very little room for any delay of the necessary action. We should recall that the government`s inflation target is just 3%, way below the 4.6% just mentioned.
The expectation of Chinese tightening has battered gold prices, which were lower to as much as $1345 per ounce during the last day of the week, as oil was similarly sold, losing around 2.65% off its value in Friday`s trading. We expect the difficulties in the commodity market to continue for the first half as the Chinese need to tighten is very real. In any case, prices of some commodities like silver and oil are probably already out-of-synch with their fundamental and technical trends, so a reversal of course will not be surprising. Still, we don`t expect the Chinese to be too aggressive with their tightening, and since the Fed will keep undermining the dollar, commodity trends will survive in the longer term, barring a major catastrophe such as a disorderly breakup of the Eurozone.
In separate developments, in a speech today Hu Jintao, the Chinese President, emphasized the necessity of "U.S. respecting Chinese sovereignty over Tibet and Taiwan", warning that acting in the opposite direction would create tensions in the Asia-Pacific region. He was rather frank in his words, saying that the history of bilateral relations shows the potential for steady growth if the countries respect each other`s points of sensitivity, concluding that "otherwise our relations will suffer constant trouble or even tension".
China`s concerns about about Tibet and Taiwan are well-known, of course. The Tibet issue is probably the easier one, since, apart from the well-publicized protests of the Dalai Lama, and the occasional censure of various international bodies and U.S. Congress, there is not the remotest possibility that the Tibetans will be able to throw away the yoke imposed on them, or that the Chinese will face any significant security risks. India, which is the only relevant Asian backer of the Dalai Lama, has been trying to improve relations with the Chinese recently, and another conflict over the Aksai Chin or any Tibet-related issue seems extremely unlikely.
The Taiwan problem is an altogether different matter. We believe that the Chinese are make a mistake by playing their cards so openly, and leaving no room for doubt in their relations with the Americans. Arguably, this is born of their desire to maintain stability through an effective diplomatic deterrent, in that, if their partners and rivals are aware of what they will not be tolerating, the risk of a conflagration should be expected to be lessened. This approach makes sense from a Chinese point of view, since they see themselves as the righteous aggressors over the Taiwan issue, defending Chinese honor and power against the humiliation of the past centuries. It also means that the Chinese do not expect the Americans to make a first move, such as inciting the Taiwanese to some declaration of independence, or an equivalent action that would force them to take action in terms defined by the U.S. It is unclear how much of a risk this poses for China over the longer term.
Apart from the propaganda value of such a stance, it is hard to see what strategic benefit the PRC gains from its current stance on the Taiwan issue. The U.S. can at any moment trigger a highly predictable Chinese response by encouraging the Taiwanese leadership to be more aggressive about the independence issue, potentially creating a crisis situation in which the Chinese have little opportunity to adapt to the emerging situation. The PRC leadership is, undoubtedly very well aware of this risk, and its very buildup of forces in the region, strong concentration of naval and air forces is probably directed at giving a clear sign of how powerful its response will be in case that a Taiwan crisis emerges. President Hu`s recent comments in the U.S. emphasizing this point, are to be understood in this context, and not a sign of belligerence or hostility, in our opinion.
On the CNY issue in Washington, Democratic Representative Sander Levin of Michigan is reported to be planning to introduce a legislation as early as Monday next week, which will be reproducing the language of a similar bill passed by the House in September 2010. Hu`s response, while being questioned on it by senators, was that the problem is that "we, the China are more productive", and "have lower labor costs", according to Senator John McCain. Not very constructive, but one cannot expect Hu to say much else either. We are surprised that he was so candid with his answer.
In short, Friday was not a good day for stocks, commodities, or risky currencies, with the dollar, yen, and bonds generally being the better performers. We don`t expect this to change much in the near term, with the trigger point being signalled by Chinese rate rises, and their end marking the reinception of the previous bull trend. On U.S.-China relations, the main concern remains the currency issue, since, as both political parties are deeply out of touch with voters, it is but a matter of time that the politically lucrative, and low-cost USDCNY issue becomes too enticing a target for exploitation. In the meantime, smiles will be maintained, since big business has as big a stake in seeing the status quo continue just as the Chinese leadership does, and with so much cash to spread around, it seems that the resolution can be delayed for quite a while.
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