Soochow: Will there be a financial war after the tariff war?

Viewpoint Tariffs are just a means of the Trump administration's global "investment attraction" strategy. In order to attract investment, financial tools can also be used. Roughly speaking, this may include, but is not limited to: First, impose a special capital gains tax on US capital holding Chinese securities assets. If high capital gains taxes force US capital to withdraw from the Hong Kong stock market. We estimate that US capital holds about 2.5 trillion Hong Kong dollars in the Hong Kong stock market now, which is equivalent to the total turnover of 10 trading days and the volume of southbound funds trading for 22 trading days since the beginning of this year. Secondly, impose a special interest tax/capital gains tax on Chinese capital holding US dollar assets. While reducing the expected rate of return for Chinese investors, it encourages these capital to flow into other areas (gold, Eurobonds, etc.), or return to China's overseas assets (Hong Kong stocks or domestic bonds issued overseas). We estimate that if there is a discriminatory tax on US dollar assets, it may affect a $3 trillion securities portfolio. Thirdly, once again threaten to completely delist Chinese concept stocks through audits, etc. Compared with the market situation in 2021/2022, most large-cap Chinese concept stocks have already listed for the second time or listed in two places. The expected delisting is estimated to have limited impact on the market. Of course, this will have a significant impact on US dollar PE. And the listing of Hong Kong IPOs has become crowded because it is one of the few exit channels. Fourth, threaten to exclude the SWIFT system. This global financial transaction infrastructure is extremely important for international trade. Decoupling from SWIFT will have a dramatic negative impact on short-term trade. However, the EU, not the US, has a dominant role in the SWIFT system. It is difficult for the SWIFT system to become a financial tool manipulated by the US. Risk Warning: 1) Historical experience does not represent the future; 2) Geopolitical risks; 3) Unexpected policies; 4) Data statistical deviations, etc. Introduction The "trade war" initiated by the Trump administration has caused widespread concerns in the global investment market. Not only because high tariffs will lead to trade contraction, reduced demand, and a global economic recession. But also because this disruptive practice lacks logic and clear goals. Investors have no logical basis for prediction, and the market is full of uncertainties. Global investors widely believe that the reasons and goals for imposing equivalent tariffs clearly lack logic. These are not equivalent tariffs. The calculation process of tariff rates has nothing to do with the tariff rates imposed by trading partners on American goods. This cannot significantly increase US tariff revenue to offset the budget deficit. High tariff rates will inevitably greatly reduce trade volume, lower the tax base, and the tariff revenue harvested will be much lower than the target value. In fact, in Trump's first term, there was a fact that tariff rates increased while trade volume decreased. This cannot change the US trade deficit. The US trade deficit is a reflection of the domestic economy. For a long time, US consumers' consumption purchases have been much larger than savings and investments, and the strong consumption power can only be satisfied through net imports. US consumption is too high (largely due to the international status of the US dollar), and domestic production cannot meet consumption. Drastically increasing tariff rates cannot directly change the fact that the US has strong consumption and weak production. Of course, if high tariffs reduce demand, cause economic recession, and lower consumption capacity, the trade deficit can indeed be reduced. The reason for the insufficient domestic production in the United States is the lack of investment/savings. Therefore, the Trump administration hopes that overseas capital, or US capital in various parts of the world, can enter/return to the United States to help production. In other words, using tariffs, the Trump administration is coercing capital to come to the US to make up for the lack of investment in the US. Unlike most developing countries that want to attract investment with preferential policies, the US attracts investment by waving the tariff stick. In order to achieve the goal of "attracting investment", the Trump administration needs to negotiate, and tariffs are an important bargaining chip. However, if tariffs are not enough to encourage other countries/regions to transfer capital to the US? Perhaps Trump needs more other bargaining chips to exert so-called "extreme pressure." This bargaining chip may be finance. After all, the United States has the largest market capitalization and the widest participation in the world. The main means of these financial wars are still taxes. 1. Additional taxes on capital flows For example, US capital invested outside the US must pay additional income tax to force/induce US capital to return to the US. A similar plan was implemented in Trump's first term in December 2017. The Trump administration lowered domestic corporate taxes while requiring that profits of US multinational companies obtained overseas must also be taxed immediately (the original provisions had exemptions, and profits not repatriated domestically did not have to be taxed temporarily). Moreover, in 2017, a one-time tax of 15.5% (8% non-cash) was levied on all untaxed profits accumulated by US companies with a 10% stake overseas. Based on the above tax logic and history, the "new" tax methods that may be implemented in the future include: Higher taxes on profits obtained by US companies in China, at a higher tax rate. For example, the current long-term (over 1 year) capital gains tax rate in the US is 0-20%, short-term (within 1 year) capital gains tax rate is 10-37%. The Trump administration could impose a 37% special capital gains tax on US companies/individuals who earn profits from investing in Chinese securities, regardless of holding period. However, additional capital gains taxes on Chinese assets may beObviously impacting the Hong Kong stock market. In the scenario of increased taxation, the investment return rate of Hong Kong stocks has significantly decreased, and American capital may be forced to sell Chinese stocks. This sell-off could have a significant negative impact on Hong Kong stocks.In the past few years, the proportion of European and American funds trading on the Hong Kong stock market still reaches nearly 50%, while the scale of southbound funds under the Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect projects was only around 20% before. Looking at the 15 Hong Kong stocks mainly held by American institutions, the average American-held market value of Hong Kong stocks accounts for 7%. Based on this calculation, the market value of Hong Kong stocks held by American capital is equivalent to the trading volume of southbound funds for 22 days now. Obviously, imposing capital gains tax on American capital holding Hong Kong stocks is a "financial war" that deserves our attention and vigilance. When necessary, it may be necessary to open up a larger scale of domestic funds to the south to cope with the pressure of American capital outflow. Second, another form of taxation in financial warfare comes from discriminatory taxation of Chinese enterprises/individuals holding US dollar assets, imposing additional taxes. As early as the third round of Sino-US strategic negotiations in 2011, American experts proposed to then US Treasury Secretary Geithner and Secretary of State Hillary Clinton to impose a special interest tax on US Treasury bonds held by the People's Bank of China. Therefore, the discriminatory taxation of Chinese investors has been widely discussed within the United States for over a decade. More than ten years ago, Joseph Gagnon and Gary Hufbauer of the Washington-based Peterson Institute for International Economics wrote in the journal Foreign Affairs. The US Treasury Department can withhold income tax on the interest on US Treasury bonds held by China. For every $10 billion of US Treasury bond interest paid to the People's Bank of China, the Treasury can withhold 30%, which is $3 billion. Imagine if the Trump administration proposed imposing a 30% interest tax on US Treasury bonds held by China. With China currently holding approximately $780 billion in US debt, assuming an average interest rate of 4%, the annual interest income is about $31.2 billion, paying a 30% interest tax would amount to $9.36 billion. At the same time, the expected return rate on holding US bonds would fall to 2.8%. This would clearly lead to China selling off US bonds and rebalancing its assets. Observing the daily trading volume of US bonds over the past 12 months, it is usually around $900 billion per day. Therefore, unless it sells off all $780 billion in bonds in a very short period of time, moderate reduction in holdings by China will not have a drastic impact on the US bond market. This may also be the basis for the US to dare to impose discriminatory interest taxes on US bonds in the future. However, things are interconnected. If the US imposes discriminatory interest taxes on US debt held by a particular country/region, this practice can be applied to any region or group that the US wishes to target in the future, which will inevitably cause widespread concern among investors. The market will definitely reduce their holdings of US bonds, causing US bond yields to rise and increasing the financing costs of the US federal government. The extent of the increase in bond yields is difficult to estimate. The long-term impact will be profound, although the short-term impact may not be particularly catastrophic. Of course, if the expected return rate on US dollar assets held by Chinese institutions/individuals significantly decreases, it will encourage these capital to flow back to Chinese assets. Hong Kong stocks may benefit. China's official net external asset size is approximately around $3 trillion, while private funds hold overseas net assets estimated to be equivalent to or roughly that size. Assuming that half of the foreign investments are in securities assets, we estimate that the scale of overseas securities assets held by Chinese investors should be around $3 trillion. Rebalancing such a huge securities portfolio will certainly have a significant impact on some assets. Examples include gold, Eurobonds, and Hong Kong stocks. Third, using various means including audit issues, to force China concept stocks to delist. This method, on the surface, has limited impact. Although during the last period of high expectations for China concept stock delisting in 2021/2022, China concept stock prices generally fell by 20%, if audit issues are used again to force China concept stocks to delist, the impact is estimated to be limited. On the one hand, most large-cap China concept stocks are already listed in both the US and Hong Kong. 31 large companies, including Alibaba, Netease, and JD.com, have been listed in both the US and Hong Kong. There are another 11 companies including Pinduoduo and Vipshop that meet the requirements to list in Hong Kong immediately. However, companies with VIE structures like Didi and iQiyi will experience a relatively significant impact on their stock prices. After all, the time spent on secondary listings or dual listings is longer. On the other hand, if the China concept stock sector disappears, it will inevitably affect primary market investments in China by US PE firms. A large amount of US capital will have to divest from their investments in China due to the lack of exit mechanisms. Many US PE firms mandate that companies can only choose to list in Hong Kong, causing crowding in the Hong Kong market and burdening the Hong Kong stock market. Whether it is increasing the capital gains tax on US investors' holdings of Chinese securities, or reigniting expectations for the delisting of China concept stocks, these types of financial warfare require China to open up a larger scale of southbound funds and constraints, to resist the outflow of US capital, meet the return of China concept stocks and the exit demands of US PE firms in the primary market. Fourth, adding barriers to China in the SWIFT system, and even threatening to remove it. The fourth form of financial warfare has also been rumored for a long time. Adding barriers to China in the SWIFT system, or even threatening to remove it. The Society for Worldwide Interbank Financial Telecommunication (SWIFT), established in 1973, is a global financial messaging network covering over 200 countries and territories, providing messaging services to 11,000 financial institutions, and can be seen as the infrastructure of the international settlement system. The ownership structure of the SWIFT system is adjusted every three years based on the activity levels of members to ensure that the most active members have the greatest say. The 25 directors of the SWIFT system are elected by the top 10 shareholders, which currently include JPMorgan Chase, Lloyds Bank, Bank of China, BNP Paribas, Citibank, among others. Nearly half of the payments in the SWIFT system are in US dollars. Companies rely on SWIFT to complete cross-border payment instruction transmissions, and if disconnected, the transaction process will be forced to turn to a longer and more costly path.The alternative channels (such as the agent bank model) make it difficult to verify the remittance information of the enterprise, increasing the complexity of operations and the risk of errors, delaying settlements and directly slowing down the flow of funds. In particular, it may result in obstacles to the import of raw materials or goods stuck in ports, leading to risks of supply chain interruption. The threat of SWIFT discontinuity could have a significant negative impact on trading enterprises, especially small and medium-sized enterprises, in the short term (3-6 months).However, the SWIFT system is regulated by G10 banks, the European Central Bank, and the Belgian Central Bank. The regulatory forum established in 2012 even includes a more diverse range of members, such as the People's Bank of China, the Hong Kong Monetary Authority, the Monetary Authority of Singapore, the Bank of Mexico, and the Saudi Arabian Monetary Authority, and so on. It must be noted that SWIFT is a neutral utility organization and does not have the power to make sanction decisions. Some past sanctions, targeting Iran, North Korea, and several Russian financial institutions, have all come from regulatory and legislative bodies. In other words, decisions made by SWIFT are more influenced by the EU Parliament. The influence of the US federal government on SWIFT is very limited. The Trump administration finds it difficult to influence SWIFT decisions through the US government. If members of the Trump cabinet mention threatening SWIFT, it is at most just empty talk. Source: WeChat public account "Chen Lichen"; GMTEight Editor: Wenwen.