2018 Predictions: How Did We Do?

20171107112553845A number of key events shaped 2018, impacting both China and the United States as well as the relationship between the two countries. First ever meetings among the leaders of North Korea, China and the United States took place. The United States and China became embroiled in a Trade War that flared up in March and grew in intensity until a meeting between U.S. President Donald Trump and China President Xi Jinping in early December produced a temporary truce. And, China implemented a deleveraging program in an effort to “de-risk” its financial system that slowed growth in key sectors of its economy such as autos.

The cumulative effect of these and other events took a toll on the stock markets of both countries, each of which had their worst performances in ten years. When the Closing Bell rang at the end of the year, the Shanghai Stock Exchange Composite Index was off 25 percent, and the Dow Jones Industrial Average had declined by just over six percent.

Despite the volatility of 2018, Managing The Dragon (MTD) fared pretty well on its predictions for the year. Of the five predictions made on January 23, four — growth in China’s exports to the United States; the pace of overseas acquisitions by Chinese companies; tensions on the Korean Peninsula and sales of New Energy Vehicles (NEVs ) — played out more or less as MTD predicted. The only prediction that did not turn out as expected was the value of the renminbi against the U.S. dollar, which fell by more than eight percent from its high, and closed the year at 6.9 to 1.0. MTD predicted the yuan would remain stable at 6.5 to the U.S. dollar.

Following in a tradition that was first established with MTD’s review of its 2009 predictions, MTD will once again review each of its predictions in detail, and award a score of from one to 20 points for each, depending on how we think we did. You may agree or disagree with the scores we assign, but we hope to at least score some points with you for our transparency and accountability.

Prediction #1: After exceptionally strong growth in 2017, China’s exports to the United States will once again break records in 2018.

In 2017, China’s exports to the United States increased by 9.3 percent, following a 4.3 percent decline in 2016. Reversing 2016’s decline, and achieving significant growth from an already large base, China’s U.S. export performance in 2017 to record levels was nothing less than impressive.

One of the biggest factors influencing the level of imports into a country is the health of the importing economy. History shows that the larger and more developed an economy becomes, the more it imports. Given the way in which factories in China have been integrated into the global supply chain, the economies of the world’s two largest trading partners are inextricably joined at the hip. As the U.S. economy has grown, so have China’s exports to the United States.

In 2015, the U.S. economy grew by 2.9 percent, and China’s exports to the United States grew by 3.1 percent. In 2016, the U.S. Gross Domestic Product (GDP) growth rate fell to 1.6 percent, and China’s U.S. exports fell by 4.3 percent. In 2017, the U.S. GDP growth rate increased to 2.2 percent, which led to the record level of imports from China in that year.

With that pattern in mind, and with the expectation of a stronger U.S. economy in 2018, MTD predicted that China’s exports to the United States would once again break records. Following 2.2 percent GDP growth in 2017 and the first quarter of 2018, the U.S. economy grew by 4.2 percent in the second quarter and 3.5 percent in the third.

With a stronger U.S. economy, China’s exports to the United States also grew, increasing by 8.3 percent through October, the latest month for which figures have been published. While it may be argued that 2018 export figures were favorably impacted by pre-buying in advance of more and higher tariffs in 2019, it is noteworthy that China’s U.S. exports for every month last year, including the months that pre-dated the onset of the Trade War, were higher than the figures for the same month in 2017.

For Prediction #1, MTD believes it deserves the full credit of 20 points.

Prediction #2: China will maintain the value of the renminbi at approximately the current exchange rate of 6.5 to 1.

Prediction #2 fell victim to the trade war.

The exchange rate between the renminbi or yuan, China’s currency, and the US dollar has been a bit of a roller coast ride in recent years, heavily influenced by the Chinese government’s efforts to control the outflow of capital from the country. An overseas acquisition binge by Chinese companies in 2015 and 2016 resulted in heavy outflows of capital during those years and caused the yuan to weaken from 6.05 to the U.S. Dollar in January 2014 to 6.95 by January 2017.

In 2017, China began restricting outbound M&A, and the yuan strengthened to 6.49 against the US dollar by Januar, 2018. Going into the New Year, and expecting another record year of exports to the United States, MTD believed that China’s leaders would be particularly sensitive to charges of currency manipulation and would do all in their power to keep the currency stable at 6.5 to 1.

Instead, negative investor sentiment caused by the trade war, coupled with interest rate increases by the U.S. Federal Reserve, has made US dollar assets more appealing for investors. As a result, China’s currency began seriously weakening in June and closed the year at 6.9 to 1.0.

Unfortunately, MTD whiffed on Prediction #2 and gets no points for this one.

Prediction #3: In the face of strong export growth, China will continue to restrict overseas investment. As a result, overseas acquisitions by Chinese companies will be flat to down in 2018.

Spurred by the desire on the part of Chinese companies to be global, as well as favorable government policies that encouraged Chinese companies to go abroad, overseas acquisitions by Chinese companies surged in 2016 and Chinese companies became important players in global mergers and acquisitions (M&A). Combined with weak exports, the heavy outflow of capital that resulted caused a significant weakening of the renminbi. In order to prop up its currency, China began dumping U.S. Treasuries at the end of 2016, using the dollars received to buy the yuan, draining the country’s foreign currency reserves in the process.

To stem the capital outflow, China imposed restrictions on overseas investment in 2017, which it tightened as the year progressed. As a result, China’s outward direct investment dropped 19.3 percent in 2017, marking the first decline recorded since 2002 according to a report from China’s Ministry of Commerce, National Bureau of Statistics and State Administration of Foreign Exchange. Given the Chinese Government’s focus on the stability of its currency, MTD believed that the government would continue to discourage overseas acquisitions by Chinese companies and that overseas M&A would continue to be weak in 2018.

With the onset of the trade war and the resulting weakness in the yuan, the Chinese government has, in fact, continued its restrictive measures on overseas acquisitions. In addition, US concerns with respect to the theft of intellectual property by Chinese companies has caused the Committee on Foreign Investment in the United States (“CFIUS”), the interagency committee authorized to review certain transactions involving foreign investment in the United States, to closely scrutinize U.S. acquisitions by Chinese companies.

As a result, the value of Chinese outbound M&A plunged by 61.2 percent in the first half of 2018, according to a report by Bain & Co., a business consultancy, with U.S. transactions particularly weak. “For the near future, it makes sense to put U.S. acquisition plans on hold,” Bain’s report said. “As a short-term measure, many are now pivoting to Europe and other non-U.S. developed markets” to buy companies that have the technology they need. Deal activity in 2018 will fall well short of the levels achieved in 2016, according to a Bloomberg report,

MTD scored another 20 points for Prediction #3.

Prediction #4: The situation with North Korea will come to a head in 2018, and China will play a constructive role, albeit behind the scenes, in the successful resolution of the crisis on the Korean Peninsula.

MTD went way out on a limb with its prediction for North Korea.

At this time last year, North Korea was reportedly within months of being able to arm ICBMs with nuclear weapons, and false alarms about incoming missiles in both Hawaii and Japan demonstrated how nervous citizens in the United States and the rest of the world had become with the prospect of a nuclear North Korea. In an interview on the subject, John Kelly, President Trump’s Chief of Staff at the time, said that, with respect to North Korea, the United States has kicked the can down the road for the past twenty-five years. “The problem at this point in time is there’s no road left. We have to deal with this guy,” Kelly concluded. Taking General Kelly at his word, MTD believed that the situation on the Korean Peninsula would come to a head in 2018 and that China would play an important role behind the scenes in the discussions.

As far as trade, it is always difficult to determine precisely what is actually happening between China and North Korea. While there are periodic reports of Chinese and North Korean ships secretly exchanging cargoes at sea, the numbers appear to tell a different story. Chinese exports to North Korea totaled $1.6 billion from January to September 2018, down 59.2 percent from the previous year, according to Beijing’s customs office. North Korea imports into China totaled $144.6 million, down by 90.1 percent from January to September. While some suggest that China might be manipulating the numbers, trade between the two countries is at such minuscule levels that it is difficult to see how even gross exaggerations would make much of a difference.

Apart from trade, China’s most important contribution to the talks between the United States and North Korea may be the “Big Brother” role that China’s President Xi has played to North Korea’s Kim Jong Un. On June 12, President Trump met in Singapore with Kim, the first between a North Korean leader and a serving U.S. President. Prior to that meeting, Kim made a surprise visit to Beijing in late March and to the northeastern city of Dalian in May, presumably to seek guidance from President Xi. For the first six years of his rule, Kim did not leave his country, even to visit with China, North Korea’s only real ally. At their third meeting in as many months, Kim met with President Xi again on June 19, just one week after Kim’s historic summit with President Trump.

Of course, we can only speculate as to what President Xi said to Kim in their three meetings, but it is safe to say that Xi was nothing if not supportive, which in and of itself may have made Kim feel less isolated and improved the climate for negotiations with the United States. China has an important geopolitical stake in seeing that the crisis on the Korean Peninsula is resolved peacefully and has largely supported the diplomatic discussions between Washington and Pyongyang, even supplying Kim with an Air China plane for his journey to Singapore. China’s state-run television, Xi lavished praise on Kim for his handling of the U.S. meeting and said he was very pleased both with the results of Kim’s Singapore talks as well as North Korea’s future goal of economic development, according to CCTV. The two men agreed to further deepen the already-close ties between Pyongyang and Beijing, according to state media.

The crisis with North Korea is far from over, but talks between the United States and North Korea have produced some positive results, most notably a one-year halt in missile testing by North Korea; a thawing of the relationship between North and South Korea; and the return of the remains of U.S. soldiers killed or captured in North Korea during the Korean War.

Given the lack of transparency from two of the world’s most mysterious countries, it is difficult to determine exactly what role Beijing has played in the discussions between the United States and North Korea. However, MTD continues to believe that President Xi and China have played an important, behind the scenes, role in supporting discussions between the two countries. As a result, MTD will take 20 points for Prediction #4.

Prediction #5: China will break the 1.0 million mark in sales of New Energy Vehicles (NEVs) in 2018.

The combination of China’s large number of densely populated cities and rising per capita incomes is creating a demand for better personal transportation alternatives that cannot be met in an environmentally sustainable way using vehicles powered by an internal combustion engine (ICE). With all of the growth experienced by China’s auto industry over the past 25 years, there is still less than one car for every six individuals in the country, compared to the United States where there is nearly one car for every man, woman and child. Under these circumstances, China simply has no choice. The country must either accept a growing number of ICE-powered vehicles, with all that implies as far as air pollution and energy dependence; restrict the transportation choices of its citizens; or embrace new technologies such as NEVs.

As a result, China has been supporting the development of NEVs with consumer subsidies, which are now being phased out and replaced by mandated NEV production targets for all assemblers operating in the country, as well as tough, new Corporate Average Fuel Economy standards. Despite China’s overall sluggish auto market in 2018, just over one million NEVs were sold in China in the first 11 months of the year, up 68 percent from the same period in 2017, according to data from the China Association of Automobile Manufacturers. For the full year of 2018, it is estimated that 1.2 million NEVs will be sold in China. This does not include an estimated 1.3 million affordable Low Speed Electric Vehicles that are used extensively in China’s Tier 2 and Tier 3 cities.

If anything, MTD was too conservative in its prediction for NEV sales in 2018. However, that will not prevent us from taking full credit, and 20 points, for Prediction #5.

2018 marked the 10th year that MTD has made five New Year Predictions, and then graded itself at the end of the year. Over the years, MTD’s scores have ranged from a low of 43 in 2011 to a high of 85 in 2015. During these 10 years, 2018 is the third year in which MTD has achieved a score of 80. With one of our most successful years of predictions behind us, MTD is ready to make its predictions for 2019. Stay tuned, and Happy New Year to all of our readers.

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