Mike Pence does not normally factor into investment decisions in Asia. But the U.S. vice president has just answered the biggest question in the markets: When might Donald Trump call a truce in his China trade war?
Not in 2019, it seems. In fact, Pence signaled to business leaders in Washington that an even more aggressive assault is coming, and not just tariffs. Pence's references to tensions in the South China Sea came days after a close encounter between U.S. and Chinese naval vessels. His accusations of Chinese meddling in next month's Congressional elections opens another theater for investors to fret over.
"We will not be intimidated," he said, speaking on Oct. 3, "We will not stand down."
Investors, though, could be excused for feeling plenty intimidated as the White House intensifies its war of attrition. It is always hard to make sense of the alphabet soup that pours out of Trump. But Pence lent credence to the view that the U.S. is hitting China less for economic reasons than political ones. Trolling Chinese President Xi Jinping's government is a key Trump/Pence re-election strategy for 2020, and markets be damned.
This has been Asia's worst fear since Trump's shock election in November 2016. And the fallout is showing up not just in darkening Chinese production data, but Hong Kong property and stocks. A year ago, the former British colony reveled in its China conduit role. Now, with the Hang Seng Index down 13% this year, it is collateral damage as Trump does his worst to sabotage Asia's biggest economy.
It is working, too, as Chinese purchasing managers' surveys stumble toward contraction. JPMorgan Chase, meantime, downgraded its view of mainland stocks, citing "no clear sign of mitigating confrontation between China and the U.S. in the near term."
Nor the long-term. Trump threatens to target as much as $500 billion of Chinese goods (his tariffs currently cover $250 billion). This growing specter clouds Asia's 2019, reaching far outside China.
It raises significant doubts about Japan's ability to sustain its longest expansion since the 1980s, and it complicates South Korea's push to address 9.9% youth unemployment. It offers Singapore and Taiwan less space to reinvent growth models. It is fanning worries in India, Indonesia, the Philippines and other emerging economies facing cratering currencies.
Yet the real problem is this: It will not be so easy this time for China to maintain 6%-plus growth.
Unlike in 2008 and 2015, Beijing faces a diminishing returns problem. China steered around the "Lehman shock" a decade ago by tossing tens of trillions of dollars of credit at the economy. The People's Bank of China turned the yuan-printing presses to maximum. Local governments rolled out massive infrastructure projects. Regulators eased rules for speculation in property markets.
The Shanghai stock crash in 2015 drew even more creative responses. As the central bank slashed interest rates, Xi's team bought shares, banned short-selling, loosened margin requirements, shut off trading in entire market sectors, suspended initial public offerings and encouraged households to buy stock out of patriotism. And just as in 2008, Beijing lavished support on the property market.
With each crisis Beijing averts, though, it is getting less bang for each yuan it pumps into the economy. In recent months, Xi's team responded to Trump's tariffs with a mix of tax cuts, new loans to businesses and infrastructure spending. The PBOC reduced the number of deposits commercial banks must hold.
Like Pavlovian dogs, home prices perked up. In August, for example, they accelerated at the fastest pace in two years -- 1.4% from a month earlier. Yet that is adding more froth to mainland real estate markets broadly. August marked the 40th straight month of home price increases, and that is no coincidence. Prices are now 30% higher than in 2015.
A new study by economists at the Federal Reserve Bank of Kansas City highlights the costs of Beijing's own war of attrition -- with property short-sellers. On the one hand, China's ability to grow its gross domestic product at 6.5% hinges greatly on the housing market. Local governments, for example, rely heavily on tax receipts from rising real estate prices. On the other, Beijing is adding to the nation's troubles with asset bubbles and the inequality they generate between the haves and have-nots.
Kansas City Fed economists found that "China's housing activity has become increasingly important to its GDP growth." A 10% decline in final demand for real estate and housing-related construction, they calculate, would take a 2.2% toll on national output. That, the report concludes, is "an effect more than two times larger than it would have been 10 years ago."
This tension between market froth and the need for stimulus is playing out in other vital parts of the economy. Markets, too, as evidenced by JPMorgan Chase's change of heart. Shanghai shares are already down 16% this year. But JPMorgan Chase makes a compelling case that the 2019 Pence is telegraphing will not be pretty for Asia's biggest economy.
"Higher tariffs are squeezing Chinese manufacturing's profit margin, reducing the investment incentive and hiring, which would then drag on consumption via reduced income," says JPMorgan Chase's Pedro Martins.
This raises valid questions about how Beijing makes its growth numbers. Expect Xi to mull additional tax tweaks, fresh spending packages, new business loans and other sweeteners. Huge ones, too, given the diminishing returns challenge. Yet it may do more to heighten Beijing's dueling bubbles in debt, credit and real estate than support growth.
Trump's trade war is throwing sand into the gears of China's all-important export engine. China does not need many more six-lane highways, international airports, ports, dams or white-elephant public works projects. Surging real estate prices in Beijing, Guangzhou, Shanghai, Shenzhen and in second- and third-tier cities around the nation may have already gone too far. Nonfinancial corporate debt has already touched the $20 trillion mark compared with $12 trillion just four years ago in 2014.
Nor is this year's 5.6% drop in the yuan versus the dollar working its usual magic. Export growth weakened to just under 10% in August from the previous month. That is markedly below the 15%-plus pace at the start of the year. Not surprisingly, recent purchasing managers' data from the government and Caixin puts the indexes at the 50 mark -- just a small step from contraction.
China, it is often said, thinks in decades. Xi is indeed focused on where China wants to be in 2025 and beyond, while Trump rarely looks past his next tweet. In this battle with Beijing, though, Trump is playing the long game and in ways that could make 2019 a more turbulent year than financial investors think.
William Pesek is an award-winning Tokyo-based journalist and author of "Japanization: What the World Can Learn from Japan's Lost Decades." He was given the 2018 prize for excellence in opinion writing by the Society of Publishers in Asia, for his work for the Nikkei Asian Review.