The China threats to Australian investors

In all the storms over US migration, visas and refugees we are inclined to take our eye off the main game for Australia – China. 

The big thing we have learned about Donald Trump as the 45th US President is that unlike most politicians around the world he is actually doing what he said he was going to do and what the American people voted him in to do. 

So now it's an established fact that he is about honouring promises (popular or unpopular), we need to look more closely at his China policy. It still remains likely that he will seek to do a deal with China, but we need to understand the potential impact of his China promises.

1. In essence, Trump made it clear that he wants to ensure an open trade route through the South China Sea and he disputes China's sovereignty over this area.

2. He threatened to classify China as a currency cheater, therefore placing a whole series of anti-Chinese measures into US trade policy that would restrict Chinese imports into the US. 

3. He is also proposing a special border tax where American companies who bought goods from overseas would not get a tax deduction for them but would get tax credits on exports.

4. And, of course, he is not a fan of China's view that Taiwan is a united part of China. 

These policies are absolutely different to anything we have seen in recent times from the US towards China. What makes the policies even more likely to be introduced is that Trump not only announced these policies but appointed Peter Navarro, an economics professor at the University of California, as the director of the National Trade Council, which is a new White House policy group to be set up. 

Navarro is one of America's most extreme hawks on China and has written several books on the subject, including 'Death by China'.

In addition, Wilbur Ross will be the commerce secretary. Ross has been highly critical of America's "dumb trade deals". 

In other words, the people that were instrumental in designing the Trump policies are going to play important roles in their implementation. That makes it harder to gain flexibility. In the Chinese policy area I am being guided by the former chairman of Morgan Stanley Asia, Stephen Roach. I know Stephen, and he has a very deep knowledge of what happens in China and is writing with other authors on a web page called Project Syndicate.

Long-term view: Trade and the South China Sea

So let's assume for a moment that talks break down and the US starts to act on its policies. China is the third-largest American export market and the fastest growing. Almost certainly that will be greatly curbed. A big slab of the Chinese funds created by the massive trade surpluses have in fact been invested in US treasuries. China has $US1.25 trillion in US treasuries and other dollar-based assets. Indeed, it is China which has played a key role in funding America's budget deficits and, as we know, Trump plans to increase the US deficits, at least in the short term. 

If he starts to act tough with China, almost certainly the Chinese will stop sending money to the US. And they might begin to sell their treasuries. Either of those two actions would cause American interest rates to rise sharply and substantially lessen the momentum of the Trump revolution. At least in isolation, if China starts to sell US treasuries, it will put the US dollar down. And Trump might reason that a falling dollar would cause Chinese loss. 

But if Trump was to actually go ahead with his border tax plan it would almost certainly push the US dollar up, and you have these two potential forces acting against each other which would cause enormous turmoil and uncertainty.

And of course, as we have discussed before, Australia's prosperity comes from shipping raw materials to China and we will be affected very quickly if there is trade turmoil between China and the US. Now into that mix we throw the South China Sea. I think history will treat President Obama very unkindly on this issue. 

The South China Sea is not just an ordinary piece of water. In our region it is the trade route that supplies Japan, China and many parts of the region. If China takes control of this sea then it is, in effect, taking control over the region including Japan. As soon as China began to invest in building islands in the sea Obama should have acted. But he did nothing except issue meaningless words which the Chinese did not take seriously. 

Now, with the military bases in place, it is much more dangerous situation. The American view is that unless there is a confrontation now it will be impossible in a few years' time and China would have gained control of the region's trade. Australia is in a hopeless position because we would normally support our major trading partner (China), but the US is essential to our defence. I am not going to even try to predict an outcome, but what is certain is that if this potential cocktail is understood by the markets we will see great fluctuation and those fluctuations will include big movements in our share market and our dollar. But that is to come. 

Short-term view: Aussie apartments

Right now the major Australian economic story which gets very little exposure in the conventional media outlets is the tightening of the restrictions on individual Chinese getting money out of China to fund residential property in Australia. As I have pointed out before, local and overseas Chinese – say, two years ago – were 80-plus per cent of the Sydney apartment market and they are now well below 50 per cent. In terms of new purchases, the overseas component has fallen to 25 per cent and is declining rapidly. 

In Melbourne it is looking more likely that those constructing apartments for Chinese buyers will discover that many of the Chinese can't fund the obligation and will renege on the deal. Of course, it is true that the Chinese are very innovative and even now are finding ways around the restrictions.

But it is harder and harder. What is holding up the apartment market is that Treasurer Scott Morrison substantially damaged confidence in superannuation as a long-term savings vehicle, and Australians have turned to negative gearing of dwellings. That portfolio shift by Australians is shifting a lot of capital out of the share and debt markets. 

Many Australians are adding a second or third home to their portfolio. And younger Australians who can't afford to buy a house or apartment as a residence are able to do it as an investment because the interest and maintenance expenditure is tax deductible. The combination of the Chinese exodus and the big rise in negative gearing means that Bill Shorten's policy of abandoning negative gearing on existing homes will certainly make residences more affordable, but there will be a big fall in the price. It will be a key battlefield in the next election. 

So we suddenly find ourselves not only the flotsam and jetsam in the US-China trade wrangle but also watching our housing/apartment markets being altered considerably by actions in Beijing.