Why a bet on Australia is as good as a bet on China 
2 Jul 2019|

The Wall Street Journal ran an article last week saying pessimistic investors were ‘short-selling’ the Australian dollar in anticipation of a disappointing outcome of the weekend’s G20 meeting.

‘Some money managers are bracing for a potential resurgence in trade tensions after President Trump’s meeting with Chinese President Xi Jinping last weekend by hedging their bets with currencies and options. Strategies include a short on the Australian dollar’, it said.

The pessimists were outweighed by optimists, and the Australian currency jumped from just below US$0.69 to just above US$0.70 in the lead-up to the G20 meeting as greater numbers punted on a successful meeting between Donald Trump and Xi Jinping. Global investors were positioning themselves for the outcome of the Osaka G20 summit in the Australian dollar market because it’s seen the best way to take a position on the Chinese economy.

It’s not easy for global investors to trade in Chinese markets. Capital controls make it hard to shift money in and out of the country at will and, in any case, the end markets do not have sufficient liquidity for big global investors. The Australian dollar is still the fifth most widely traded currency in the world so liquidity is not a problem and it is used as a proxy because no other G20 economy is so closely hitched to the fortunes of the Chinese economy.

But Prime Minister Scott Morrison moved decisively ahead of the G20 meeting to back the United States’s trade complaints about China, saying there was legitimate concern about its economic structure and policy practice. It was an unusually strong critique, signalling the priority that the Morrison government will place on the United States alliance.

‘Forced technology transfer is unfair. Intellectual property theft cannot be justified. Industrial subsidies are promoting over-production,’ he told an Asialink meeting before setting off to the G20.

China, of course, contests each of these claims from the United States. Although endlessly repeated, they are also debated by some international observers. The Economist reported earlier this year that Chinese intellectual property protection was improving at ‘rocket speed’.

‘As Chinese firms issue more patents, the keener they are to protect them,’ The Economist said, noting that China was responsible for 44% of all international patent applications in 2017, twice as many as from the US.

A study by US legal firm Rouse found that foreign businesses in China have a better success rate in intellectual property cases before the Chinese courts than do domestic Chinese firms, and are awarded more damages overall.

The article said that although patent and copyright theft are problems in China, the courts are getting tougher and a special appeals court dealing with intellectual property has been established at the Supreme People’s Court in Beijing.

It’s not an issue that was raised when Australia was negotiating its free trade agreement with China, which includes a chapter on intellectual property, essentially confirming the application of international agreements.

Morrison also backed the US claim that China should be treated as an advanced nation in the World Trade Organization.

He said China’s rise had now reached a ‘threshold level of economic maturity’.

While we acknowledge that large parts of China are still to realise the prosperity of its major economic centres, it is also true that its most economically successful provinces, some of which are larger than many developed nations, including Australia, have reached and sometimes exceeds the economic sophistication of its global competitors. Yet, at the same time, these economies get to compete with concessions, whether they be on trade, environmental obligations or other terms, not available to other developed economies.

The WTO treaty contains a series of concessional terms for developing nations and allows countries to self-determine their status. This has become a major issue for the US as it seeks to wind back its trade deficit. The US wants not only China to lose its developing country status, it is also suggesting that so too should all members of the G20 (including Indonesia, India and South Africa) and all nations with exports of more than 0.5% of world trade (including Thailand, Vietnam and Colombia).

A report by the Peterson Institute for International Economics says the gains from developing country status are not great—they only apply to reciprocal agreements in a multilateral framework. Export industries in which developing nations are gaining competitiveness are unlikely to be covered. Developing countries say the World Bank’s measure of per capita income should be the benchmark. China’s per capita income is still only $US9,770 per annum, which far short of the average for high income nations of $US44,700.

A paper prepared for the WTO by China, Indonesia and South Africa noted that the gap between the incomes of advanced and developing countries has been widening, not getting narrower. Australia does not have an obvious stake in this argument and the government’s decision to back the US on developing country status may cause issues with regional neighbours besides China.

Most economists argue the Trump administration’s concern to narrow its trade deficit with China has no foundation in economic theory and that the US deficit is the result of its savings and investment decisions and is endlessly sustainable. However, there is enough evidence that in some parts of the United States, Chinese competition has caused painful dislocation as firms in industries like furniture-making and textiles have been forced out of business.

Australia, by contrast, has been an unequivocal winner from its trade with China, which has had a transformative effect on the economy. It has elevated the nation to the world’s leading supplier of minerals and energy resources while also propelling its education and tourism industries to the top tier of global competitors.

Australia’s imports from China have improved living standards for Australian consumers and lowered costs for many businesses. The nominal value of goods exports to China rose 44% between 2011–12 and 2017–18. Exports to all other markets rose by just 6.6% in that period. China’s share of Australia’s exports has risen from 28.6% to 35.1% since the end of the resources boom.

Australia now sells as much to China as it does to the entire OECD. Ten years ago, exports to the advanced nations were twice the size of Australia’s sales to China. China contributes a disproportionate share of supply as well as demand. Over the six-year period noted above, merchandise imports from China rose 57.5%, three times the 18.6% growth in imports from all other suppliers.

It’s the strength of this bilateral linkage that leads world financial markets to conclude that a bet on Australia is as good as a bet on China.