An uneasy sense of calm returned to markets this week. That is until Monday late afternoon. The price of oil had been weak for some time, and West Texas Intermediate (or WTI) was trading at around $18 per barrel, down from a recent high above $60. It then began to weaken further, and this accelerated into the close of trading in an alarming fashion. From $18, to $3, to below zero, to finish at a price of -$39 per barrel. So, if you owned a barrel, you would happily pay someone $39 to take it off your hands. Whilst this was the first time in the history of oil markets that such a thing had happened the reason turned out to be obvious (with hindsight).

When you buy WTI in the market, you are committed to taking delivery of the actual oil. This is fine as traders simply roll each month’s futures into the next month. Real purchasers take delivery. This week however, because of the severe collapse in demand for oil (no travel, by air or road, contraction in industrial production), the resulting glut of oil was so severe that storage had run out. Whoever ended up holding the baby had to find a way to store it – the price of floating capacity (tankers) rocketed, meaning the oil was worse than worthless.

24 APRIL 2020

As to the drivers of markets, aside from the oil debacle, investors are now focused on the way in which economies can withdraw the lockdown measures currently in place. The virus (subject to possible second waves) has peaked globally and social pressure to get back to normal is building everywhere, led by the free market of the US.

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European countries are leading the way – in Germany certain retail stores, bookshops and car dealerships are open this week; children are returning to school in Norway, whilst open air markets have re-opened again in the Czech Republic. In the US, President Trump has left it to individual states to decide timing and extent (whilst backing the anti-lockdown protesters). In Georgia for example many retail outlets are open this week, including gyms, barber shops and bowling alleys (go figure).

All this is encouraging and playing to the timeline of a more general move back toward normality into May and June. In the meantime, fiscal and monetary support has still been forthcoming, and as noted previously provides a substantial, and likely sufficient bridge back to more normal economic activity.

As for South Africa, we remain with a relatively small number of daily cases of the virus (albeit not declining) and the President announced a fiscal stimulus this week amounting to R500bn. We continue to monitor the progression of the virus, and take a cautious view of our way ahead. The economic stimulus package announced is substantial, and essential. Let us hope it is enough, and gets delivered in expeditious fashion.

The Rand meanwhile has continued to be weak, as emerging market currencies generally continue to flounder against the mighty US dollar. Overall, however it is worth noting that emerging market currencies are trading at historic lows. If we see a move back to a more risk-on environment, the Rand should benefit as emerging market currencies recover.

All of which leaves us globally – as forecasted – with a V-shaped recovery with activity at more normal levels in the second half and markets having now recovered to levels where we are on firmer ground.

THE RISE OF CHINA – DO THEY WIN POST THE VIRUS?It is worth now taking a step back and assessing the current trajectory of the seemingly inexorable rise of China, and how the current downturn may affect it. In short will China continue to win against the US?

As noted last week, China has recovered quite well already, emerging early from the virus (an isolated outbreak in the north-eastern city of Harbin notwithstanding) with activity back to 80-90% of normal levels. Progress from these levels however appears to be quite slow, impacted presumably by weak levels of global demand for product. Domestic interest rates were, as expected, reduced this week; and we expect more cuts and additional fiscal stimulus, so as to ensure a robust recovery. If the authorities reiterate a growth target above 5% expect aggressive fiscal easing. Whilst the Chinese are back at work, certain global trends will help their recovery, others will hinder.

1. A second half recovery in global activity would help China’s export markets, a critical driver for their recovery.

2. The reaction of other major powers to their geopolitical dependence on China and its exports. Nations are likely to want to shorten their global supply chains, reduce their dependence on China and manufacture more locally and sustainably. As one rather notable example, the US is dependent on Chinese factories for a large percentage of its healthcare medicines – an extremely uncomfortable position to have found itself in – the US imports over 60% of its Personal Protective Equipment (PPE) from China.

3. China will need a cheaper Renminbi. This is a problem. The US dollar is strong and overvalued. President Trump will want it cheaper, to help stimulate the US economy. The Chinese want the reverse to stimulate theirs. This has been a flashpoint in the past and ahead of the US election, expect it to come back with a vengeance.

4. Production has been steadily moving away from China as their wages have caught up with many places (now above those in Mexico) and cheap manufacturing has moved to Vietnam and elsewhere in South East Asia (and to Mexico). This trend is likely to accelerate.

5. The Chinese authorities were engineering a shift in their economy from manufacturing to consumption. This was succeeding in an almost seamless fashion. China is now facing a rather more abrupt shift, at least away from manufacturing. Stimulus will need to be enormous to kick start consumption again.

It is far from clear that China will win this war with the US, at least in the near term. Much depends on the wherewithal of the Chinese regime to stimulate their economy back to growth, and quickly.

WHAT ABOUT THE LONGER TERM, AND CHINA’S STARTLING GLOBAL AMBITIONS – A NEW EMPIRE?To understand this, one needs to take a quick history lesson, not from the perspective of the West, but from the East. For 3 500 of its 4 000-year history China has been a great world power - for much of the time, the great world power. The Xia dynasty from (2070 BC-1600 BC) was followed by the dynasties of Shang, Zhou, Han and Qing, until in 1912 the great revolution spawned the Republic of China. The Chinese Civil War of 1927-49 brought Chairman Mao to power and the formation of The Peoples Republic of China with Mao as the brutal Head of

the ruling Communist Party. The Great Leap Forward and the Cultural Revolution followed until Mao’s death in 1976, leaving behind the massacre of 70 million civilians in peacetime – a number not seen before or since. Deng Xiaoping assumed power in 1978 and set in train the economic reforms that, 40 years later have resulted in average GDP growth of 6% pa, and the lifting of countless millions of people from poverty to middle class status. Integration of Hong Kong from the UK (1997) and Macau from Portugal (1999) completed the picture, with Hong Kong as the finance and trading hub (now possibly eclipsed by Shanghai) and Macau the gaming hub to satisfy the Chinese voracious gambling habit.

It was around 1500 AD however that the turning point for China really came, the lessons from which resonate today, and form the backbone for the current strategy of Chinese World domination (yes that).

The peak of the ancient Chinese Empire was marked by the completion of the Forbidden City in 1420, in the reign of the Ming Emperor Yongle. Built in the heart of Beijing it comprised nearly a thousand buildings, and took more than a million workers 14 years to build. The greatest of the Ming emperors, Yongle was a true visionary and pushed the Chinese Empire to new heights. The compendium of Chinese learnings he commissioned filled more than 11 000 volumes and took the work of 2 000 scholars to complete. It stood as the greatest encyclopedia of human knowledge until the advent of Wikipedia in 2007.

In contrast at this time, Europe was in disarray. In London, the bubonic plague known as the Black Death had reduced the population of London to just 40 000 (a tenth of that of Beijing). Living conditions, in stark contrast to those in China were abject; life expectancy in London was a paltry 28. One in three children died in childbirth. Violence was rife. The annual murder rate in Oxford, England was more than 100 per 100 000. The murder rate in Cape Town is currently 66 per 100 000; Gauteng, Durban and PE less than two thirds that – making Cape Town the 11th most dangerous city in the World (after ten cities in South America).

China had already led the world in many innovations, being the first to discover and produce the mechanical clock (1086), printing press (11th century) and blast furnace to produce iron (200 BC). As late as 1788 British iron production levels were lower than those achieved in China in 1078. This despite the widely known reputation of the British for the iron-led Industrial Revolution of the late 1800s. And the claim of Germany of inventing the first printing press in the 15th century. The list of Chinese inventions goes on – matches, paper, compass, playing cards, toothbrush – and even golf. A game called Chui wan, played with ten clubs, including three woods. The clubs were inlaid with jade and gold, setting the scene for what is still in some quarters considered a game for the elites.

But most importantly China was active and audacious in overseas markets. Yongle luxuriated in a fleet of over 300 vessels, and a navy of 28 000 seamen; bigger than anything in the West until WWI. Yongle’s fleet journeyed far and wide, to Thailand, Singapore, India, Saudi Arabia, and Africa. On their visit to Malindi (now Kenya) the Sultan presented the Chinese delegation with the gift of a live giraffe. This was duly taken back to the Emperor Yongle who displayed it with great pride as a symbol of "perfect virtue, perfect government and perfect harmony in the empire and the universe".

Source: Niall Ferguson - Civilisation.

But in 1424, Emperor Yongle died and the dream of empire died with him. All overseas missions were suspended, to the extent that by 1500 anyone in China found with a ship with more than two masts was liable to death. The great expansionary Chinese age of Empire was over.

Source: Niall Ferguson - Civilisation.

The Chinese nation turned inward, and slowly fell back in its influence and prosperity. Finally, in 1912, after years of unrest and riots, as the state of the nation unravelled, the Great Revolution occurred, bringing in the Republic of China, and subsequently Mao and Deng Xiaoping.

This long and bitter experience has informed current Chinese thinking as they renew afresh their global ambitions. They will not make the same mistake again of turning inward from the world. They will strive every sinew to remain one united nation. And they now again have the financial might, growing military capability and naval strength to embark on overseas expansion.

As part of this long term strategic vision, China also needs to establish and control trade corridors to ensure supply of global commodities and other needed materials to feed its inexorable growth. Such barter trades have been ongoing for the past 20 years, across Africa, Asia and now Europe. Financing for

Source: Niall Ferguson - Civilisation.

roads, ports and other infrastructure in exchange for cheap debt and control over mining output, and the routes back to China. No questions asked. A win-win for all – until the debt bill becomes too onerous, and a debt for equity swap swiftly ensues, bringing permanent ownership of ports, mining facilities and related trading infrastructure to China. The new Chinese Empire is being established, under our noses – the currency of conquest this time being not military, but finance.

The strategic framework that ties together this grand ambition is the Belt and Road Initiative (BRI). This strategic expansion was announced by Beijing in 2003, and aims to spread Chinese infrastructure, loans and influence across 68 countries. The routes will follow the ancient overland and maritime trade routes established along the old "Silk Road” – previously the Chinese sphere of influence across its trade routes during the time of the Great Chinese Empire. The project has a completion date of 2049, to coincide with the 100th anniversary of the Peoples Republic of China. This vast network of influence will cover two thirds of the world's population and almost half of world GDP. China will spend up to $8 trillion on the Initiative.

It is to say the least a grand plan. If it succeeds, and likely way before 2049, the Chinese will again be the great world power.

Risks however are mounting.

Economic growth in China has averaged 6% p.a. for the past 30 years. Its current GDP is $13.4 trillion, compared to the US at $21.4 trillion. Based on purchasing power parity (PPP), China’s GDP is $25.3 trillion, exceeding that of the US.

China’s share of world trade already exceeds that of the US.

But with world trade fading already as globalisation runs out of steam, this puts China at some risk, post virus.

And, in terms of GDP/Capita, the real measure of a nation's wealth and well-being, China, even in terms of PPP is way behind the US. Based on estimates from the World Bank, the Gini coefficient (a measure of income inequality) in China is 39, ranked 68th in the World. South Africa is tragically No 1 at a coefficient of 63. The UK is 33, the US 41. Plenty of social inequality to go around in China, and the country has a long history of social unrest and disquiet (albeit very well suppressed).

As mentioned last week, the Faustian Pact of China with its people is, make me wealthy, and you can keep my vote. This means migration to higher paying jobs in the cities. This must continue and depends on continued high rates of GDP growth.

And Chinese domination of the US also depends on size (and resultant global reach and associated military spend). Again, China simply has to keep growing quickly. And the demographic footprint from the one child policy will not help. By 2030 16% of the population will be over the age of 65. In 1980 this share was 5%.

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China has also become more and more indebted as it has undergone repeated stimuli to keep the machine running. Whilst this is no different to many nations post virus spend, it is new for China, and may undermine its profound global ambitions. Government debt in China (including local municipality debt), is by some estimates now well north of 100% of GDP.

SUMMARYChina has enormous resource, political will and ability to coalesce around its common mission for great global influence. It should not be underestimated. It also has the lessons of history on its side and the ability to take a very long strategic view. It would be unwise to bet against it. However, risks have risen, in particular due to COVID19 and the resulting potential acceleration of reduced globalisation. China’s ability to continue to grow against a more testing (and critical) global backdrop will be key – and tested like never before. Its populace will be watching. The current recession in China is its first in 40 years. It has to recover quickly; however, the state of world demand may preclude it. It is an intense irony. The virus that originated in China, and caused havoc across the World, and from which China is recovering first, may still be the thing that derails the Great Chinese Project.

Elize and Hywel