Sorry for not posting something more quantitative over the weekend, but collecting CAB and Money Supply numbers in Hong Kong is taking it’s sweet time, as will modeling the Hang Seng Index returns from there. Both this and my entropy measure of equity market risk writeup have been pushed to next week. In the mean time:
Some good moves out of East Asia, if these rumors reported on by The Diplomat are true. Japan would thus in the Senkaku / Diaoyu dispute back down a bit, and acknowledge that there is a dispute over the territory. Now this might seem incredibly tiny or downright puny, but what it does do is a) open up a negotiation avenue, b) allows China to save face, and c) strengthen Abe’s position at home. Previously, Japan had not even been willing to negotiate with China on the matter “as there was nothing to dispute”, while for example a recognition that a dispute existed with Taiwan allowed fishing rights to be negotiated on and sets a relatively good precedent. It gives China a long-sought concession and with a bit of luck it allows Xi to keep the militaristic Jiang Zemin-bred faction running the Standing Committee of the Politburo at bay. Abe can also score some points at home by stepping back from one of his most popularly disliked policies domestically in Japan.
What does the negotiation table look like, then?
In my view, these two economies are like two extreme tests of the East Asian economic style, at different stages of development. China is growing but needs markets to export to and know-how to import, while Japan arguably has a lot of those last two but seems very close to being unable to find sustainable growth after 25 years of looking. Japanese companies forming aggressive joint venture structures with Chinese firms, or investing in production over there seems like a match made in heaven, and doesn’t get too deep into the sticky politics of either country. Negotiation could bring either party a lot of benefits, and opening up for reasoned discussions on broad economic cooperation must be worth the yen-price of a lot of concessions on a rock in the ocean that’s a day-trip by boat away from Taiwan. China arguably gets off a lot easier with 7%+ growth…
Yet any strong political reform in China will need a lot of “cushioning” economically. I doubt even Xi Jinping can stand against internal party discontent from continued anti-corruption campaigns while suppressing the abuse of land by local governments for financing, together with a local population facing regulatory change but little perceived economic improvements while having their capital herded into pension- and insurance firms. Something’s got to give, and I really think that the best candidate for this would be the astronomically high RRR in China, where I believe China could probably sustain a 15-17% RRR in the intermediate term, and potentially 12-15% long-term. (17%: 17.6% increase in aggregate loans-to-reserves ratio, 15%: 33.3% increased A-LTR, 12%: 66.7% added A-LTR from current levels of ~20% RRR.) Another thing that is possible for the Chinese government to do is to make major trade easier, and exporting to Japan while having an open avenue to their more advanced machinery and general technology sectors would surely be a very good way to strengthen the industrial capacity to add value in China without painful corporate efficiency improvements and research expenditures. Yes, total trade is not that big of a deal compared to the rest of China’s GDP, but it does add a lot of added value and allows more capital to flow through the economy, which could be incredibly crucial given the relatively tight credit at the moment.
Domestically, I am a strong believer in Abe actually siding with the Japanese public on this and taking a much more friendly tone to China. Any step away from the nationalist factions he has to contend with at home while shoring up his public approvals will be crucial, since he might very well have to face a trial by fire this quarter when it comes to the consumption tax increases that would be slated possibly for this time next year. Additional reform packages might become harder to push through a recalcitrant political structure, but at least his ability to add extra value to the Japanese economy through trade (if not through opening up other channels for Mrs. Watanabe to squirrel yen out of Japan and build/support the net yen short) would let Abe get a breather and some policy wins under his belt before moving on.
Arguably, the results of this might not be seen immediately, and telling whether something has been said will probably not be easily seen in the open. Still, I look at my world in differential equations, and anything that might put the derivatives on the positive side for better change is something I will cheer on!
