Rate Hikes, Trade War Start Panic In China – Chinese Citizens Have Plenty To Be Worried About

China’s stock market has lost a couple trillion dollars in value in the last few weeks – presumably owing to fears of an intensified trade war with the US. That’s a lot of money – even for the People’s Republic of China (PRC).

But this isn’t supposed to happen. After all, the Chinese Communist Party (CCP) has brilliant Ivy League educated men with the wisdom of the Orient running the economy and the markets, and they ‘think long term’. So just a little tinkering here and there keeps the economy and markets humming along – unlike the boom and bust Western economies.

The CCP knows this is untrue. But there are Westerners that believe it for them – thinking the PRC’s rulers know how to run an economy better than any people in history – and that economic principles – or better said a couple thousand years of experience and human nature – don’t apply in the PRC.

Notably, very few of the aforementioned Westerners actually risk their own money in China.

Of course, a stock market isn’t the sum total of an economy. But governments often regard them as reflections on their competence. And since the CCP’s claim to unchallenged rule implicitly depends on economic performance, a roiled market matters a lot.

The Chinese economy, like any economy, is at least half-psychological. What people think about their current and future prospects matters as much as money supply, interest rates, bond spreads, and the like. And once people have enough doubt, things can go to hell rather fast.

It happened three years ago when the Shanghai stock market plummeted – and the Chinese government burned through $1 trillion of its $4 trillion in foreign exchange reserves to temporarily shore things up – while suspending trading and threatening securities firms they’d better buy shares ‘or else.’ Short-sellers were threatened with arrest, and analysts and officials who were too negative were arrested.

Recently, a Chinese think-tank, the National Institute for Finance Development warned of financial panic potentially leading to financial crisis. It pointed to this year’s cascade of bond defaults, tightened liquidity, and declining stock markets and weakening Yuan. The report added that US interest rate hikes and a looming trade war suggest ‘the Chinese people are very likely to experience a financial panic very soon.’

It’s always hard to predict when panic will hit. But psychology matters just as much in authoritarian nations as in free ones. And maybe even more – given unspoken but deep-seated cynicism about fundamentally corrupt systems where ‘connections’ and ‘position’ – not impartially applied laws or concepts of individual liberty – are what matter. Indeed, as Cuba, Venezuela, Iran, Russia – and even the PRC – demonstrate, being able to imprison people or shoot them doesn’t make an economy run any better.

And Chinese citizens have plenty to be cynical, and worried, about.

Start with the lack of property rights – and fear of losing everything at the whim of the Party or its officials. Beijing residents were reminded of this last winter when unregistered residents were driven out of their shabby dwellings in the cold and sent packing to their rural hometowns.

And being really rich is no protection in China as tycoons often have problems with the State – to include difficulty staying out of prison or even staying alive. If these people aren’t safe, who is?

Adding to this uncertainty is plenty of corruption at all levels, despite President Xi’s anti-corruption drive – that seems to avoid his family, friends, and allies.

Despite regime propaganda of an arms-linked populace aiming to restore Chinese greatness, all isn’t calm in the PRC. China’s domestic security budget is bigger than its ‘regular’ defense budget, and the regime no longer reports on popular demonstrations – though word sometimes leaks out. With the right spark – such as a serious economic stumble – angry citizens such as the truckers and military veterans who protested recently might as easily turn their attention on Zhongnanhai and the CCP leadership.

For years, just about anyone in China who can – even at the top of the CCP – endeavors to move their wealth (along with a family member) to somewhere safe – such as the US, Canada, UK, or Australia – out of reach of the CCP and where honest legal systems function and there’s respect for individual and property rights.

Like a sort of futures market, this suggests China’s most successful citizens are betting against the PRC’s future prospects.

So if the economy stumbles badly and the idea gets around that the CCP can’t handle the economy any better than it handled population growth with it’s ‘one-child policy’– there’s trouble in store for the Party. And it doesn’t matter if people love their country – which the Chinese do. They love their savings and property – and being treated fairly and governed competently – at least as much.

Mr. Trump has China frightened. And this is something new for an American President. It’s usually the other way around. The Trump administration worries less about cheap products at Wal-Mart and more about a rigged China market that disadvantages American companies as it seeks to destroy them over the long term.

The President’s threats of trade sanctions and other economic pressure worry the CCP. And it ought to worry – given the threat to foreign direct investment, foreign exchange earnings, and technology on which China’s economy depends. And it’s not just Mr. Trump. More American and foreign companies are sheepishly realizing they’ve been displaying ‘battered wife’ syndrome while spending years trying to hit it big in the China market.

But Mr. Trump needs to get his strategy right. Tariffs are a problem for the PRC – especially if wide-ranging and forcefully maintained for a long period – but can be answered tit-for-tat, creating hysteria in parts of US industry and commentariat.

The President was doing better going after the Chinese telecom company, ZTE, and putting it on ‘death row’. This terrified the PRC leadership. It exposed key parts of the Chinese economy’s dependence on foreign technology – and as importantly – the foreign exchange earned from exports that is the PRC’s lifeblood. There’s a long list of other potential ‘ZTE’s’ the US might target.

All in all, not exactly the rosy picture PRC media and officialdom depicts of brilliant ‘meritocrats’ guiding China’s economic development from strength to strength and inexorable global dominance.

Mr. Trump needs to keep the pressure on – not offer ZTE a ‘way out’ – as he appears determined to do, perhaps thinking the PRC will appreciate the favor and reciprocate elsewhere. It never does.

And if he really wants to demonstrate the CCP has no magic formula for running an economy, just insist on a ‘reciprocal’ treatment standard so that Chinese companies in the US receive the same treatment as American companies in China. And that includes no strong-arm technology handovers or state-sponsored technology theft. If the CCP can’t kick that habit, the US can help them.

So, we’ll see where this trade war goes. But if the PRC economy sputters or worse and if its citizens blame the CCP – then it won’t matter much if Shenzhen has the most skyscrapers on the planet or Shanghai’s Pudong district was rice fields not long ago.

Rather, there’ll be trouble in Zhongnanhai – and another real estate boom in Vancouver.