China: Looking for tells in Beijing

Source: Asia Society

Caro

Ahead of next week's US-China Strategic & Economic Dialogue, investors are sifting through pieces like this one from the Paulson Institute and this one by the diplomats who negotiated China's accession to the World Trade Organization, to determine what to watch for when policymakers from Beijing and Washington turn to the bilateral investment treaty. Personally, I'll be rereading Caro's Book of Poker Tells, a masterpiece that belongs on every investor's bookshelf.

Why? First of all, I'm not looking for any groundbreaking announcements from this meeting. Tensions between Beijing and Washington are much higher than usual, and investment treaties take a long time to negotiate, even in the best of times. But I am hopeful that the meetings will generate some insights into the biggest question on my mind right now: how bad is the situation in China? 

High stakes

If you think the stakes in Macau are high, listen to the conversations among investors, business leaders, and politicians in Beijing. These days, that's where the action is. China is facing its biggest challenge since welcoming capitalism 40 years ago. A combination of high leverage, faltering real estate prices, and a slowing economy are creating a perfect storm that threatens to devastate the Chinese economy, destroy the rally in risk assets, and undermine growth from Brazil to Nigeria.

Source: The Economist

The risks are enormous, but the mood among investors is cautiously optimistic (like everything else these days). Optimists note Beijing's resources (including $4 trillion in reserves) and growing awareness of the problem. Pessimists recognize that Beijing has the ammunition, but worry that those officials at the commanding heights of the economy could commit a fatal policy error. No matter where you are in this debate, everybody agrees on one thing: the stakes couldn't be higher.

Looking for tells in Beijing

Moments like this demand that we move our analysis beyond the data and beneath the headlines. That's where Mike Caro comes in. At its core, Caro's book is about "tells" -- verbal and non-verbal cues that unconsciously reveal information about other players. What separates the best poker players from everyone else is not their mastery of the math or strategy behind the game. It's their ability to turn seemingly innocuous behaviors into powerful insights.

Chris "Jesus" Ferguson

The best time to spot an opponent's tell is during a big hand. Even the most seasoned professionals struggle to conceal their emotions when the stakes are high. The hand I will be watching most closely next week will be dealt as soon as someone mentions the bilateral investment treaty. That's when we could discern some new and important insights into Beijing's strategy for heading off the crisis -- as long as we're wearing our sunglasses.

The Chinese government seems aware of these problems and committed to helping banks repair their balance sheets while building a foundation for a safer system going forward. But, as we know from our own crisis (and as Janet Yellen admitted yesterday), stabilizing a financial system featuring a complicated and interconnected web of commercial banks and shadow banks is extremely hard. Beijing needs creative solutions -- and fast.

The impossible dream

I would love to see China welcome a bilateral investment treaty, but I doubt that will happen. American equity capital could rescue China's growth ambitions, while banks and non-banks alike head to the bench for a much-needed balance sheet breather. Even though American multinationals couldn't provide all the capital China needs to meet its expansion targets, the move would signal Beijing's recognition that more capital has to come from sources outside its embattled financial system.

But Beijing won't tip its hand that easily. For one thing, the government has maintained the appearance that everything is under control. PBOC governor Zhou Xiaochuan has been sending soothing messages to reassure the markets. Furthermore, we're not exactly at a high point in Sino-American relations. Tensions over cyber surveillance, the South China Sea, and currency manipulation have made this a bad year for the world's most important couple. So, even if Beijing believes the bilateral investment treaty could stabilize the situation, geo-strategic considerations dictate that Chinese officials maintain their best poker faces when dealing with their counterparts from Washington.

Watching the S&ED with sunglasses

It's going to take a discerning eye to ascertain any insights from the S&ED, but conditions are ripe for someone on the Chinese side to give something away. China's financial situation looks increasingly precarious, and emotions among government leaders are hot. The FT reported that growing concerns about a banking crisis has strained relations between China's top two regulators. I doubt they're the only ones in Beijing who feel anxious about a pending crisis.

I'm not expecting anything major when leaders from both sides meet next week, but you can bet I'll have my eye out for nervous fingers, enlarged pupils, or any other tells from the Chinese side, especially when the conversation turns to the bilateral investment treaty. A lot of chips are on the line.