Whenever I take one of those “personality tests” that circulate so frequently on social media, I inevitably wind up on the cusp of introvert and extrovert.
I can’t help it, really… that’s just how I’m wired. So much so that it has always manifested itself in my likes, dislikes and day-to-day life.
The sport I was best at – baseball – is a team sport. But the competition that functions as that sports centerpiece – pitcher versus batter – is one on one.
I spent the better part of my 20’s in a 4-piece rock band playing shows in front of hundreds – occasionally thousands – of people.
But when I wasn’t on tour, I could generally be found in a small room either practicing or teaching one student at a time.
And now in this part of my career, my time is split between consulting, publishing, and giving presentations – all of which are team-oriented or public-facing – and sitting alone at a desk buried in a balance of books, articles, databases, and spreadsheets.
Usually, that desk time is skewed pretty heavily toward the articles, databases, and spreadsheets. I mean, if you’re reading this, you’re probably familiar with how data-driven my articles tend to be.
But yesterday was different… I read an entire 500-page book cover-to-cover.
In these biweekly missives, I’ve occasionally tried to outline some of the potential threats to global geopolitical stability.
And while I’m not necessarily doing that because we’re in some kind of imminent danger, I do subscribe the view that the absence of stability has a negative effect on financial markets, as that is clearly supported in the data.
Source: Bloomberg, State Street Global Advisors
But it is a constant struggle to keep up with all those moving parts, much less stitch them together into a coherent worldview. So, whenever the opportunity arises to access the brain of a genuine expert on such matters, I jump at the chance.
In the natural resource and finance industries, I’m fortunate enough to have a pretty solid Rolodex at this point in my career. So, if I have a question about something, I can usually just make a phone call.
But if the question is related to politics, history or the military, I typically have to pick up a book to gain a personal perspective.
When a book’s central theme sits at the intersection of all three of those topics – especially if it also touches on what is happening today – it becomes essential reading.
The book provides an informed, experienced, distinctly nonpartisan view of six distinct fronts were it is essential for America to compete – Russia, South Asia (Afghanistan, Pakistan and India), the Middle East, Iran, North Korea, and of course, China.
While I have a feeling that I’ll discuss some of the others in future columns, it is critical for all of us to understand China.
Obsession With Control, Consumed by Fear
The overarching assumption the US had always made with regard to China had not fundamentally changed from the time that President Nixon stepped foot in their country, through Deng Xiaoping’s economic market reforms in the 70’s and 80’s, or even through much of the last decade.
We assumed, McMaster writes, “after being welcomed into the international political and economic order, China would play by the rules, open its markets, and privatize its economy. And as the country became more prosperous, the Chinese government would respect the rights of its people and liberalize.”
At best, that was wishful thinking. But in McMaster’s view, it went one step further into what international relations pioneer Hans Morgenthau called “strategic narcissism” – the tendency for us “to view the world only in relation to the United States.”
This huge mistake in foreign policy didn’t happen by accident – the voters of this nation, motivated primarily by their own perceived self-interests, managed to elect four consecutive Presidents without any prior experience in the matter.
And while it is a correctable error, the fix requires us to understand much more than our own goals regarding how we interact with the world. We also must understand how the world looks at others, and how their perceptions and ambitions influence their actions.
McMaster argues – in the vein of the “godfather of American sinology,” John King Fairbank – that to understand China’s perceptions and ambitions requires a deep knowledge of Chinese history.
That history came into full view on his first official State visit there in 2017, when President Xi Jinping threw a lavish reception for the US Presidential delegation. That reception took the group to three distinct sites: the Forbidden City (the traditional seat of the Chinese Empire); the Great Hall of the People (essentially a monument to Mao’s Communist Government), and Tiananmen Square (the site of both Mao’s mausoleum and protests put down by the government).
The message, according to McMaster, was that Xi considers himself a new Emperor of sorts, soliciting tribute from visiting dignitaries, and orchestrating a “great rejuvenation of the Chinese nation” that will return them to their perceived dominant “Middle Kingdom” status.
But while all that pomp and circumstance are meant to project confidence, McMaster says that “they belied profound insecurity.”
I agree… after all, to some arguable extent there is a natural social cycle of humans.
Or in McMaster’s words, “the sweep of Chinese dynastic history reveals cycles of prosperity followed by increased population; the growth of corruption; some combination of natural disaster, famine, rebellion, and civil war; political and economic decline; and, finally, collapse.”
And as I wrote back at the beginning of the month, they’re so short on food that prices for corn, soybeans, and lean hogs were skyrocketing.
Next on that list comes rebellion or civil war… and that is what the Xi and the Chinese Communist Party fear more than anything.
As a result, they try to maintain control through autocratic hierarchy and force. But as McMaster notes, “control (in Imperial times) and today required protecting China not only from internal influences that might challenge the hierarchical order, but also from threats along China’s vast frontier.”
Sadly, economic data seems to be bearing that out.
Devil In the Details?
This morning’s reading was a little more familiar in scope for me, as I turned my eyes to China’s steel sector.
One thing that I’ve noticed since the trade war started was that China’s crude steel production (white line) has continued to trend higher, while total steel exports (blue line) have trended significantly lower.
Largely, the explanation has heretofore been that domestic consumption is increasing due to China’s Belt and Road Initiative.
OK, fine… I get it.
But since the COVID crisis hit, I’ve noticed a greater-than-usual disconnection between the data China makes publicly available and data available from other entities.
This morning, I read through a report issued by Barclays that outlines the effect COVID has had on several industries, including mining and steel.
The first thing I noticed was that the Air Quality Index for the steel hubs indicates an increase in activity.
Source: Barclays, AQI
And yet, inventories were rising and capacity utilization was starting to decline, when it should be going the other direction.
And top-level production itself appears to be in decline as well (albeit from a very high level).
My thought process at this point was that if production is up overall, but overall capacity utilization is down, there must be somewhere within the country that is just running like gangbusters, otherwise the data makes no sense.
And while I did manage to find an answer, it wasn’t much of a relief. It turns out that Southwestern China’s steel industry is running pretty hot, and is currently sitting at a 3-year high capacity utilization of around 85%.
To refresh your memory, this area is comprised of Tibet and the Ladakh region – where China recently clashed on the border with India.
A buildup of local steel production in such a landlocked region likely means that output is destined for nearby infrastructure. Moreover, a large portion of that we should assume is dedicated toward military support, as their buildup in the region has increased significantly since the trade war started.
And worse still, it’s a region where China has reportedly forced 500,000 farmers into labor camps.
It’s hard not to view this in context of Xi’s principle goal – China’s dominance and self-sufficiency.
In his book, McMaster likens it to the story of Ming Dynasty Admiral Zheng He, who built a fleet of ships, sailed them around the world and collected tributes from foreign lands…
… only to return to China and have the Emperor declare that the world had nothing of use for them.
Instead, the Emperor ordered the treasure-laden ships scuttled and closed all of China’s ports – a path which I discussed as a possibility back in August.
The takeaway now is the same as the takeaway then – an isolated China is one that is heavily dependent on gold and other precious metals to conduct any essential international business.
So if you don’t’ yet own a little Proshares Ultra Gold (NYSEArca: UGL), now is a good time to pick it up.
And while you’re at it, grab some Proshares Ultra Silver (NYSEArca: AGQ), as both commodities have corrected significantly over the past few sessions.
Because at the end of the day, whether China is retreating inward or preparing to transform this cold war into a hot one – just like I said above – the absence of geopolitical stability has a negative effect on financial markets.
All the best,