Could Asia be different this time?
That the rise of China is leading to shifts in the tectonic plates which link economies together is broadly acknowledged by most. And yet most presentations I hear about global economics barely, if at all, make mention of Chinese influence.
Our friends at CrossBorder have published an interesting strategic paper making the case that the trajectory of Asia will differ significantly from the West over the next economic cycle. While Asian markets may not be immune to a downturn in markets, they expect them to behave differently and recover much more quickly.
Their first piece of evidence is the rise of a distinct Asian liquidity cycle. This can be seen statistically in the collapse in the correlation between US and Asian liquidity, and is a result of a clear change in Chinese priorities. Beijing’s long-term objective is to have the yuan replace the dollar as the major global trading currency. Today they have switched to spending surplus cash on their Belt and Road project in Asia – effectively their version of the post-war Marshall Plan – rather than investing it into US Treasuries. This is a factor behind the rise in US yields over the past year and can be seen in the fact that aggregate Chinese holdings of Treasuries have flat-lined over the past 18 months.
The Bank of Japan has reacted by switching from its traditional targeting of liquidity to targeting the yen’s currency rates against a basket of currencies including the yuan. The yen has traditionally been highly volatile against the US$, for example almost halving between 2012 and 2016. Over the past two years it has traded in a much narrower range. Tokyo has, like Beijing, stopped purchases of US Treasuries over the last two years.
From a market perspective, we think this makes Asia relatively more attractive as a long-term investment, albeit Japan in particular will be more pro-cyclical because it will now be more closely aligned with China. Lower correlations are also attractive from a diversification perspective, even disregarding potential returns. On the negative side US Treasuries continue to be vulnerable to further ‘buyers’ strikes’, let alone selling, and the US$ is potentially vulnerable.
As background to the interactions between the US, China and Japan, I thoroughly recommend Richard McGregor’s book ‘Asia’s Reckoning’, which gives a sense of the three-way power games these nations have been playing since the last war.
Find out more by purchasing the report here (and spot the mis-spelling of linchpin in it!).