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Corona and the real political implications for China GEOPOLITICAL REPORT / FEBRUARY 2020

The sudden spike in new Corona virus (nCoV) casualties announced by the Chinese authorities on 13 February has been explained away by a change in the criteria used to diagnose the illness. In theory this is meant to reduce the impact of a 25% leap in patient numbers and a 40% leap in fatalities; now – goes the message – we have a better handle on what is going on. In practice, however, it indicates that previous figures have been driven not by the number of those infected, but by the authorities’ capacity to diagnose them – suggesting the possibility of a huge hinterland of casualties that has yet to be mapped.Certainly, most potential sufferers of the illness seem now to be detained in quarantine centres – hotels, municipal buildings, barracks – where (according to family members) they undertake no diagnostic tests and receive no medical attention. They can therefore contract and even die from nCoV without troubling the official tallies at all.At the moment it is impossible to tell if such a hinterland of casualties exists. What is true is that China’s statistics primarily serve the purposes of the Chinese Communist Party (CCP), not transparency. And Beijing has a powerful interest in reporting as few nCoV casualties as possible. All of China now understands – thanks to whistleblowers and citizen journalists – that the virus emerged in Wuhan at the beginning of December and was identified as a Corona- type organism two weeks later; but that the authorities undertook no quarantine or public information measures until the middle of January, for fear of undermining the city and Hubei province CCP in the eyes of Beijing. These four weeks of silence allowed over a million people to pass through Wuhan as the virus took hold, turning an outbreak into an epidemic. The Hubei CCP chief has now paid for this silence with his job. Yet this is not enough to allow the party off the hook. Chinese citizens are clearly linking the scale of the outbreak to the actions of the party; the higher the toll, and the more lethal the illness, the more damage is done to theCCP’s legitimacy. It is therefore in Beijing’s interests to report only what it cannot conceal. Deaths in hospitals will be hard to hide. Deaths in motels will not. Numbers of infections, of course, will be even easier to conceal; the only constraint on the authorities is the fact that they have already identified a nCoV death rate of 1-2%, and while they might like to suggest the virus is less lethal, this figure has effectively been set in stone. Expect casualty tallies to remain 50-100 times those of fatalities for most of the duration of the outbreak.The unreliability of Chinese statistics leaves the outside world in a state of uncertainty. Fears of a pandemic seem for the moment to be overblown; the draconian control measures undertaken by the Chinese authorities – which have effectively shut in over 400 million people – seem likely to contain oubreaks of infection, allowing them to run their local course outside Wuhan by the end of the month. Yet nCoV appears to have a 14-day asymptomatic incubation period, and is infectious for at least half of that time. The period of silence also coincided with preparations for the lunar New Year holiday, when much of the country returns to family homes and villages. It would be very surprising if two or three cycles of infection had not occurred in many of these locations before the first symptoms were reported and the control measures were introduced. And it is striking that graphs of increases in reported casualties do not yet reflect the behaviour of the virus as it has been described, while reported cases are still rising in Wuhan, over three weeks after the city was locked down. The worst is certainly yet to come.

Where does this leave investors?

Much will depend on how long the outbreak lasts. Meaningful economic activity halted at the end of January in the areas responsible for 2/3 of China’s GDP, and while the country as a whole ordinarily comes to a standstill over the lunar New Year holiday, activity swiftly resumes a week later. Now, however, it has not. Two and a half weeks on, property sales are flatlining at zero; road congestion remains at its lunar New Year trough; and while the country was supposed to return to work in the first week of February – with the government claiming 70% of factories were reopening – so far it has not. (For instance, only 10% of chip-maker Foxconn’s employees have returned to work, meaning it has yet to restart production.) This halt to economic activity is a function of the control measures imposed by Beijing, rather than nCoV itself, so the sooner the measures are lifted, the quicker China should bounce back. Estimates of the impact of this shutdown suggest that lifting the measures by the end of February should limit the damage to year on year GDP growth slowing from 6% in Q4 2019 to 2% in Q1 2020. Lasting economic damage in China should be limited, given the importance the CCP will attach to over- production – to make up for lost ground – in the period after control measures are lifted.Psychological economic damage, on the other hand – loss of confidence in the CCP and its project, reflected in capital flight and even emigration – may take longer to repair.These effects may even be out of proportion to the picture the outside world gleans of the outbreak. Many Chinese citizens’ experience of nCoV will bear little relation to the messages Beijing is pushing out through the WHO. It will be of the widespread loss of assumed liberties, a tightening of party control, and limited or no medical assistance for family members identified as vulnerable to the virus. This will do lasting damage to China’s social contract, particularly in the younger generation. And this in turn will doubtless undermine confidence in ordinarily buoyant stock markets and the country’s property bubble at a time of managed economic transition to slower growth.The virus’s knock-on effects will also be felt in emerging markets in the region. Chinese tourism has halted, with international arrivals at Bangkok and Phuket airports (for instance) at half their mid-January levels (Lunar New Year patterns would ordinarily see a fall of about 10% in overall arrivals).Hong Kong is particularly exposed; mainland tourism represents 7% of its overall GDP. Supply chains have been disrupted, with car makers shutting down plants or assembly lines in Korea and Japan because of component shortages, and the effects of vessels and cargoes being stranded in the wrong locations, or even unable to dock, likely to linger, particularly in Taiwan, Vietnam, Malaysia and Thailand.

Wider impacts include effects on commodity prices, with iron ore down 15% and oil down 25% on early January highs. (Rates charged for shipping oil from the Middle East to China have dropped by about 85%, indicating a void in demand.) These all represent blips, rather than crises – but they will be real nonetheless.What if controls remain in place throughout March?While all of the effects identified above will be magnified, it is perhaps the psychological economic damage that will be greatest. The CCP will be seen to have utterly failed in its principal responsibility – the protection of the people –entirely for its own institutional ends (hence the comparison with the Chernobyl disaster in the Soviet Union). This will translate into a significant loss of confidence in the CCP’s economic system. Attempts to stop capital flight into overseas property, US treasuries and Euro bonds would almost certainly include strong capital controls, with knock-on effects for normal economic activity. Chinese and Hong Kong markets would suffer a significant loss of confidence, with the impact lessened by massive inflows from the central bank (often through capital freed up by selling US treasuries and the possible abandonment of far flung Belt and Road initiatives), and shadow trading. The Chinese and Hong Kong property markets would also probably be hit hard, though the effects might again be limited by reporting crackdowns and the introduction of bureaucratic measures to obstruct changes of ownership. China’s digital titans would also suffer significantly, as state efforts to manage any crisis in confidence would hinge on shutting down internet access, controlling online discussion, and co-opting online economic activity. Political consequences would include the institutionalisation of the supposedly temporary CCP mechanisms of control introduced during the outbreak, increasing the brittleness of the system and a significant medium term uptick in popular opposition to local party structures and projects, with a small – but nevertheless real– risk of system failure.More narrowly, it is difficult to see Hong Kong’sgovernment surviving a prolonged outbreak; confidence in it is already extremely low, both locally and in Beijing, Hong Kongers see the outbreak as evidence of why the CCP cannot be trusted, and Xi Jinping’s tolerance for the political volatility and anti-mainland sentiment likely to emerge in the wake of a prolonged outbreak is likely to be nil. Some form of shadow Beijing government (ie a significant shift towards direct control from Beijing of Hong Kong) would surely follow.

“The CCP will be seen to have utterly failed in its principal responsibility – the protection of the people – entirely for its own institutional ends (hence the comparison with the Chernobyl disaster in the Soviet Union)”

“But now China will not buy US goods at even good faith levels; its priority, post nCoV, will be resuming normal economic activity, not spending huge sums on often superfluous and arbitrarily- determined quotas” Impact on US-China Phase One trade dealYet if the scale of the impacts identified above is dependent on the duration of Beijing’s draconian control measures, there is one major outcome that is guaranteed, however long the outbreak lasts. The US-China Phase One trade deal is dead. This ceasefire in President Trump’strade war with Beijing hinges on over $240bn of Chinese purchases of US goods in 2020. This was always going to be a difficult target to reach, in part because the US sectors involved were likely to face significant shortfalls (of 25%- 40%) in producing the quantities called for. The deal also included a guarantee of future disputes, should both sides choose it – namely allowing each side to rely on its own statistical measures of purchases, without providing for a third-party reconciliation mechanism. If both sides had been ready to make willing, then China would have bought as much as it could and the US would have been ready to accept those good faith efforts – particularly if it appeared as though the Phase Two deal negotiations (over structural changes to China’s trade and economy) would never really get off the ground. But now China will not buy US goods at even good faith levels; its priority, post nCoV, will be resuming normal economic activity, not spending huge sums on often superfluous and arbitrarily-determined quotas. March 2021 was always going to provide the possibility of a reigniting of US-China trade hostilities, as that is when the US Trade Representative’s official figures for China’s2020 purchases would come in. Now that reignition seems guaranteed, unless the US decides to hold fire; and if Donald Trump is re-elected, it is difficult to see him doing so.If Phase One is dead, Phase Two – always problematic –will never happen. Underpinning it is the CCP’s need to surrender the state’s over-dominant role in the economy. But nCoV has strengthened central political control, and recovery – likely to be Beijing-directed – will confirm Xi’sconfidence in and reliance on state-owned enterprises. Under Xi, threats to the centre’s authority in any sphere are dealt with by a tightening of central control. It is difficult to believe he would be willing to enter into any meaningful discussion of surrendering any aspect of that control, particularly as the rationale behind the measures to control nCoV – a national mobilisation of people and party – could easily be trotted out to contain the impact of any sustained US trade hostilities.It turns out that nCoV will have a serious and permanent impact after all. Current market buoyancy may prove merely the eye of the storm.

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