A New Cold War and a New Hot Freight Market?

Like me you may have read many recent articles about the evolving Cold War between the US and China. Opinions vary (of course) and run along a spectrum from ‘No it isn’t’ denial to a nostalgic ‘It isn’t as existential as US-USSR Cold War 1.0’ to a political-economic ‘This is about mutually exclusive values‘ to an outright forecast of ‘The Coming War on China’ – title of a popular independent TV documentary made five years ago by a veteran UK news reporter John Pilger.

The Sino-American political relationship affects their friends and allies in unwelcome and uncomfortable ways. Australia is America’s key ally in the Southern Pacific but it is China’s key supplier of iron ore and a leading supplier of coal. Upset by Australia’s insistence on an inquiry into the origins of Covid19, China has sanctioned Australian agricultural exports but not its mineral exports. Australian miners are making hay as China ramps up steel production and Brazil’s exports are hampered by the coronavirus pandemic. BHP has announced a 4% rise in annual production to  281 Mn T as spot iron ore prices rise above USD 100 per tonne. You’ve seen the positive effects on the Baltic Dry Index in 2Q2020 – which is pretty much what I predicted in our own Dry Cargo Outlook published in March this year.

The UK has vacillated on allowing China’s Huawei to build its 5G telephone network after the US ban on the mobile company. The UK Government has put a five year brake on Huawei’s involvement which seems designed to appease the US while offering a post-Trump U-turn to allow Huawei back in.  That won’t impress Beijing much, where anti-British sentiment remains strong over the longstanding dispute around Hong Kong.  China has promised retaliation after the UK said it would allow Hong Kong citizens born before 1997 the right to settle permanently in the UK, though it’s hard to see what tit-for-tat measures are available – maybe cyberattacks to undermine the UK as Scottish politicians push for another independence referendum.

The Belt and Road Initiative, for so long marketed as panda-diplomacy and a ‘win-win’ deal of mutual benefits for China and the countries it invests in, is showing signs of strain. While countries in every continent have signed up, many are now finding internal political opposition to  schemes which seem to exclude domestic labour, finance and content in favour of imported workers, capital and goods. And China’s relationship with India is also deteriorating as increasing tension over their Himalayan border raises anti-Chinese and Hindu nationalist sentiment in the world’s largest democracy.

China itself seems to be uncertain about how to handle its deteriorating relationship with the US and the West. Allegations of human rights abuses in Xinjiang and Hong Kong do not resonate with a one-party state which follows a policy of keeping politics and trade as separate as possible. The reliably nationalist Global Times newspaper / Beijing propaganda sheet alternatively rattles sabres and claims victim status. The Twitter feed of its editor Hu Xijin makes for interesting reading as it exposes exactly the policy conflict China faces – how to continue its essential ‘opening up’ to the world economy for China’s own benefit, while facing the imposition of trade barriers with some of its most important trade partners. China’s foreign minster Wang Yi has mourned a low point in US-China relations since they were re-established in 1979. But he offers no meaningful solutions, which seems an admission that the two nations’ value systems are indeed mutually exclusive.

This key international economic relationship seems destined to worsen and there are bound to be effects on trade that will affect shipping.  China’s territorial claims in the South China Sea undermine UN conventions on freedom of the seas, which is of concern to us all.  How China interacts and absorbs Hong Kong (and presumably eventually Taiwan, as President Xi seems bent on an Anschluss with what the CCP sees as a rebel island state) could have effects on Asian financial markets. The lessons of 1996-98 should warn us of the global consequences that could have.

Perhaps of greater concern to shipping, China has already moved to secure its maritime supply chain through increasing its share of the global fleet. Via State Owned Enterprises, Hong Kong corporations, or entities part listed overseas, China now controls around 20 per cent of the global bulk carrier and oil tanker fleets. Via the vast Cosco group the Chinese state is  the fourth largest controller of container ships.  Should tit-for-tat sanctions escalate, we may find that a greater proportion of China’s international trade ends up being carried on Chinese ships. China’s trade may be handled increasingly by the treaty ports it is building which are connected to the ‘string of pearls’ naval bases which now stretch as far as Djibouti – with West African and Latin American ports firmly on the agenda.

China already pays for commodities from some trade partners in yuan; it may begin to insist on paying for freight in yuan too.  Perhaps the biggest damage China could inflict on the US would be to undermine the position of the US dollar as the world’s main reserve currency. You’d be right to point out that this would harm China as it is the biggest investor in US T-bills. But China would not want to crash the dollar, only to reduce the threat of US interference in its trade, as American courts claim global oversight of all dollar-denominated transactions.

The US dollar is already weakening this year due to the Covid19 recession and the Federal Reserve’s very loose monetary policy response. Considerable uncertainty over the direction of the US economy and the result of this year’s Presidential election is evident.  (The two most-read articles in today’s Financial Times are “Nasdaq hits record high as US technology shares gain” and “US Covid-19 surge could trigger a double-dip recession.”)

A weaker dollar is of great interest to those of us exposed to the global freight markets, as a weak dollar usually implies higher freight rates. Those of you who have read my reports over the years will know that this is a theme I have returned to many times and that (for whatever reason) it is especially pertinent to the dry bulk market, perhaps as lower dollar-finance costs encourage investment in emerging markets.  Covid-19 may skew the model somewhat, but you may also remember my oft-repeated tip:  it’s not easy to forecast freight markets, but ask your banks what their prediction for the value of the dollar is by the end of the year. If the majority of their forecasts are pointing in the same direction, then you have some confidence that the inverse is the more likely freight market direction.

Our little industry, integral to all but beholden to none, struggles to influence policy at any level, but we can be cognisant of these policy developments in order to make better decisions and try to make hay while the sun shines.