Has the U.S. gone mad? At least a dozen sources – from hedge-fund managers in New York to equity salespeople in Hong Kong and private bankers in Shanghai – found themselves asking this question after Bloomberg News reported Friday that the Trump administration is discussing ways to limit U.S. investment into China. The possible measures proposed are sweeping, including a halt to China Inc. listings in New York and limiting how much U.S. government pension funds can invest in mainland markets. Within 24 hours, a Treasury official said there aren’t any current plans to ban Chinese companies from U.S. exchanges – “at this time.”
The first question is whether the White House has the legal power to make such changes. A quick answer appears to be no.The Treasury’s Office of Foreign Assets Control does have the ability to block any individual or firm that violates U.S. sanctions. However, the department must have concrete evidence that such infractions occurred.
“The U.S. does not have the authority to simply block transactions with China. The bar for action is very high,” UBS Group AG wrote in a weekend note to clients. To pull this off, the Trump administration will have to go through Congress first, the bank said.
Even if it’s just bluster, the damage is already done. China’s financial elites now see the U.S. shifting the front of its trade war to financial markets – in part because its campaigns on the tariff and technology fronts haven’t been going so well. One reason is that China is still a heavily managed economy. Whereas President Donald Trump has to wait for higher tariffs to seep into consumers’ budgets before he can steer their behaviors, Beijing can simply tell its state-owned enterprises, such as Cofco Corp., to stop buying U.S. soybeans. That snaps the backbone of American farmers – Trump’s key supporters – a lot more quickly than any pain Trump can inflict in reverse. As for blocking semiconductor exports to China, that hasn’t gone according to plan either. Anticipating supply shortages, Huawei Technologies Co. had been stockpiling materials for months, and is now making its own chips.
The war on capital is likely to face a similar fate. It could even backfire.
Banning Chinese companies from the stock exchanges in New York? If we put aside the penny stocks and just look at firms with a market capitalization of at least $10 billion, China Inc. would need to take out more than $650 billion in bank loans to take their firms private. Where will that money come from? Not U.S. banks. Fearful of retaliation from the Trump administration, they’ll be loath to provide financing. In a black-swan scenario, then, Beijing will have no choice but to sell a sizable chunk of its $1.1 trillion Treasury holdings. If you thought this month’s liquidity squeeze in the U.S. repo market was nerve-wracking, just imagine what will happen when Beijing undoes a decade of the Federal Reserve’s quantitative easing.
As for blocking U.S. money from investing in Chinese companies, that will be equally difficult to pull off in practice. What’s considered “American capital” anyway? By any reasonable definition, European firms borrowing dollars in Hong Kong to invest in Chinese firms listed there could qualify. In a world of negative interest rates, pension funds already have trouble meeting their liabilities as Americans live longer. Foregoing the opportunity to invest in the world’s largest emerging market – where positive returns can still be made – is purely self-defeating.
In any negotiation, as Trump well knows, there’s nothing worse than a threat that has no bite. Now that the U.S. has shown its cards, Beijing must be quietly preparing its plan B. Perhaps taking a page out of Russia’s playbook and diversifying away from U.S. Treasuries isn’t such a bad idea. The adults among us can only shake our heads.