What does China want?

What did Germany want in the 1930s? A little respect, a little less bullying, and a bit more space. Germans felt aggrieved at the terms of Versailles, that reparations had gone too far and that they had been unfairly treated. What did Russia want in the 1950s? Security. Russia was driven by fear, that it was being contained, constrained, outmanoeuvred and threatened by a new Germany supported by the USA.

In the aftermath of WWII, America decided that the only way to avoid being drawn into another costly conflict, in money and lives, was a prosperous and united Europe. Europe was in dire straits with regionwide depression and deprivation which animated the communist threat. Before the fall of Berlin, the trust between Russia and the allies had already broken down. America believed that the only way to prevent another war, this time with erstwhile ally Russia, was to strengthen Europe and to do it economically and financially through the European Recovery Program, a.k.a. the Marshall Plan, a 12 billion dollar aid program to rebuild Western Europe, and militarily, through NATO.

The Marshall Plan was neither charity nor ambition but a logical if unusual alignment of self-interest and compassion. America was motivated by fear of another costly war, and the impact of a weak Europe on the US economy. It also recognized the dire conditions in Europe after the war. The Marshall Plan was established to rebuild Europe and unite it under democratic, capitalist principles. The Russians, however, saw this as American expansionism and actively resisted it wherever possible. American hopes that an economic solution would be enough were misplaced and, in the end, a military solution was established to support the Marshall Plan. The view that European economic union and NATO are part of American expansionism, or Russian containment, has survived the dissolution of the USSR and persist even today.

Since the fall of communism, America has not required a coherent and strategic foreign policy. Absent a competing ideology, capitalism has been allowed to evolve in suboptimal ways. America, facing a decline in global influence has turned towards isolationism and insularity. Today’s America has turned away from global trade, threatening and imposing sanctions on friend and foe alike. Its trade war with China has escalated and is unlikely to find a significant or durable resolution. Progress is likely to be more cosmetic than material.

What America wants is to be left alone to prosper. It feels aggrieved that the world has prospered at its cost. It provides security yet pays more in military investment than its allies. It invests more in technology, yet others steal its technology. Its trade balances are evidence of massive freeloading by the likes of China and other partners. It feels unfairly treated and wants reparation. An industrial policy of cost containment through outsourcing has led to significant intellectual property transfer to China to aid the development of manufacturing capacity in China to suit US consumption needs. A weak USD and an increasing current account deficit are evidence of this policy and its efficacy.

The global financial crisis of 2008 led to lower economic growth and a beggar-thy-neighbour growth policy. Since then the world has been in a trade war, albeit a cold one, fought both in currency, in re-shoring and only latterly in open warfare characterized by tariffs and embargoes. Once an expedient, outsourcing and the concomitant IP transfer it necessitated were no longer convenient. The extent of American reliance on China was exposed leading to popular backlash. The narratives supporting this policy redirection included IP theft, unfair trade practices, and more incredibly, national security. What America wants is to be less reliant on China, and to contain China, to compete with China for influence, prestige and power and to maintain its hegemony in the face of China’s rising economic and political power.

Generally, what America wants is power, prestige and privilege. What it doesn’t want is to pay the price associated with that hegemony. It definitely doesn’t want China to supplant it as leader in the world and it is dismayed by China’s willingness and ability to buy prestige, power and privilege.

Now China. What any country wants is a high and rising standard of living for its citizens, markets for its goods, resources for its economy, and security for its borders and interests. It also wants to be treated fairly and with respect and dignity in the international community. Often, in the pursuit of its interests, countries are happy to subordinate the interests of others to its own, leading to war and conquest. There are costs associated with every action.

With a large population, albeit an ageing one, China has sufficient domestic demand to sustain its economy. It needs to ensure that growth can provide gainful employment to the labour force and that labour costs do not rise out of control. The macro prudential policy levers that the central bank and government have decided to activate are adequate for this type of control, given the increase in quantity and quality of data that China is now collecting. On the manufacturing front, China needs to ensure that it has access to resources at reasonable rates. To this end it is investing heavily abroad to secure such access. The Belt and Road Initiative (BRI) involving financial institutions such as the Asian Infrastructure Investment Bank and the Silk Road Fund is a broad program of investment in infrastructure and development stretching from Europe to East Asia.

Just as the Marshall Plan was interpreted as partially a martial plan, so the BRI has come to be viewed by some, not least America, as being China’s weapon of mass influence, a device for extending China’s economic power and ambition abroad.

Note that the Marshall Plan would not have stood on its own. The reaction of the Russians almost guaranteed that a military plan was necessary, hence NATO. The BRI is a laudable plan which will bring investment, growth and development to its members. Given current geopolitical sentiment, the question is, can the BRI stand alone as an economic program without a concomitant martial plan? This will depend on America’s response, generally, to China’s rise. Already the BRI has come under criticism for its environment, social and governance (ESG) credentials. Critics warn that the BRI is an instrument of Chinese oppression, and that the large-scale infrastructural investments will have adverse impact on the environment and society along its path. Yet China has shown leadership in many respects. It has made significant improvements in the environment. Air quality around the country has improved in the last five years to the extent that Beijing will drop out of the top 200 most polluted cities by the end of 2019. China and the City of London Corporation’s Green Finance Initiative have worked together to create the Green Investment Principles (GIP) for the Belt and Road.

Resistance to China’s rise will likely result in mutual escalation. Whereas the Chinese are unlikely to have territorial ambitions outside of the South China Sea, they may be forced into more robust military expansion if they feel their interests are generally threatened. It is unlikely the Chinese feel threatened by her Central Asian neighbours to the west. These Central Asian states are unlikely to find much strategic support from America; proximity to Russia complicates any American plan of support. A greater risk is China’s treatment of Muslim minorities in Xinjiang which could trigger sympathy from her Muslim dominated neighbours. America’s efforts could at best extend to agitating anti-Chinese sentiment by throwing a spotlight on Beijing’s treatment of its own Muslim population. This will likely be of limited effect given America’s own relationship with Islam. Russia and China have a marriage of convenience which is unlikely to be upset by current geopolitical conditions. If anything, America’s rivalrous engagement is likely to strengthen Sino-Russian ties. This leaves the South China Sea where China is staking a robust claim. Taiwan, Japan, Vietnam and Korea are potential locations for a US proxy war, but Hong Kong and Macau make better targets because they are part of Chinese territory. The cold war between the US and China is likely to waged in more than geographical dimensions. Weapons in cyberspace have infinite range, depth and scale. Rivalry for dominance in global financial infrastructure will have more impact in an increasingly electronic world. In payment systems, the all-important underlying plumbing of the financial system, China, Russia and India are cooperating on an alternative to SWIFT, linking Russia’s SPFS with China’s CIPS. The Asian Infrastructure Investment Bank (AIIB) is a Chinese sponsored development bank rivalling World Bank and the IMF and has to date attracted 75 members including India, Russia, Germany, Korea and France. The USA is not a member.

The rise of China presents challenges and opportunities. America, as the incumbent hegemon, can resist China by trying to contain it, or it can engage it constructively. President Trump has so far adopted a strategy of confrontation. In a zero-sum game, this may be a suitable strategy. However, the odds of a poor outcome are high. A world split between a China bloc and an America bloc may even flourish, but the missed opportunity of cooperation will be a pity. The risk of confrontation leading to victory for one and defeat for the other is high, with serious costs to both sides. Equally risky is if the cost of hostility is high enough that the global aggregate standard of living is impaired, a loss to all. Far better for America, in her current state of strength, prosperity and wisdom, to engage constructively with China, a country equally strong, prosperous and wise, for mutual understanding and benefit. Wise, empathic and strategic leaders are necessary for engagement.

Human history is replete with class oppression. In an unequal society the natural tendency is for those of superior wealth or power to maintain supremacy. This often requires some form of oppression.

Persuasion is greater than force. Efficient oppression involves convincing the oppressed that they are not oppressed or that their wealth and welfare are improving. Less efficient oppression is more overt and involves the use of force or law or artificial legitimacy, but is all ultimately backed by force.

The efficient oppressor addresses the welfare of the oppressed, aiming and working to continually improve welfare and standards of living, at least in absolute terms. The aim of oppression is to maintain relative supremacy and therefore it is necessary to ensure that the rates of growth experienced by the oppressed pale in comparison to the rates of growth of the oppressors. However, it is important to at least maintain a positive growth rate for the oppressed. 

When average growth rates are insufficiently high and rates of growth for the oppressed fall to negative levels, the risk of revolt rises. Moderately or temporary re-distributive policies can maintain the status quo which is preferable to regime change.

In the face of slow growth and high inequality, reluctance to adopt some re-distributive relief policies can lead to revolt and regression to oppression by force. This is inefficient.

The last decade is characterized precisely by slow growth and high inequality, conditions conducive to spontaneous revolt. Incidences of passive aggressive revolt and outright revolt have been rising. The ostensible catalysts appear unrelated, petrol taxes in France, extradition laws in Hong Kong, separatists in Catalunya, isolationism in the US and the rise of populists in Europe. The common thread is disenchantment with the status quo and the desire for any kind of change.

The enemy without has often been a convenient distraction for the enemy within. Could it be that the absence of an enemy without, a nemesis, has created a vacuum inducing an enemy within? Could the demise of communism have allowed capitalism to outgrow itself and transform the efficient oppressor into an inefficient one? Might capitalism balanced with communism have had to maintain some limits or moderation and avoided the extreme conditions that have emerged? Given current conditions, what can be done to prevent escalation?

Something to slow down the informational transmission of a society to increase informational efficiency. Since each node has an optimal rate of processing information, a network that transmits information too quickly is not efficient. Fools serve a useful purpose and should be valued.

The entire process of moving a drug from design to clinical trials takes 10 to 12 years on average.

Preclinical studies

Deciding whether a drug is ready for clinical trials (the so-called move from bench to bedside) involves extensive preclinical studies that yield preliminary efficacy, toxicity, pharmacokinetic and safety information. Wide doses of the drug are tested using in vitro (test tube or cell culture) and in vivo (animal) experiments, and it is also possible to perform in silico profiling using computer models of the drug–target interactions. As in clinical trials, there are certain types of trials that have to be done, such as toxicology studies in most cases, and other trials that are specific to the particular study compound or question.

Phase 0 clinical trial

Phase 0 involves exploratory, first-in-human (FIH) trials that are run according to FDA guidelines. Also called human microdose studies, they have single sub-therapeutic doses given to 10 to 15 subjects and yield pharmacokinetic data or help with imaging specific targets without introducing pharmacological effects. Pharmaceutical companies perform Phase 0 studies to decide which of their drug candidates has the best pharmacokinetic parameters in humans.

Phase I

Phase I trials are the first tests of a drug with a small number of healthy human subjects. Patients are generally only used if the mechanism of action of a drug indicates that it will not be tolerated in healthy people. They are primarily designed to assess the safety and tolerability of a drug, but the pharmacokinetics and, if possible, the pharmacodynamics are also measured. The typical Phase I trial has a single ascending dose (SAD) design, meaning that subjects are dosed in small groups called cohorts. Each member of a cohort might receive a single dose of the study drug or a placebo. A very low dose is used for the first cohort. The dose is then escalated in the next cohort if safety and tolerability allow. Dose escalation is stopped when maximum tolerability and/or maximum exposure is reached. SAD studies are usually followed by multiple ascending dose (MAD) studies, which have a very similar design, with cohorts and escalating doses. The only difference is that the subjects receive multiple doses of the study drug or placebo. While safety and tolerability are still important endpoints, the multiple dose setting often allows first investigations of the pharmacodynamic effects in addition to the pharmacokinetics. Depending on the risk potential and the safety and tolerability revealed by the SAD study, many MAD studies may already involve patients rather than healthy individuals. That said, it is important to enrol a relatively healthy patient population with as few complications and concomitant diseases as possible.

Phase II

Phase II trials are performed on larger groups of patients and are designed to assess the efficacy of the drug and to continue the Phase I safety assessments. Most importantly, Phase II clinical studies help to establish therapeutic doses for the large-scale Phase III studies.
Phase II studies are sometimes divided into Phases IIA and IIB. Phase IIA is designed to assess dosing requirements whereas Phase IIB focuses on drug efficacy. The exact design of Phase II studies depends heavily on the compound’s mechanism of action. A proof-of-concept study should be included in Phase II if it has not already been done during the MAD-study in Phase I. In addition, a treatment study with several different doses of the compound in comparison with a placebo and/or an active comparator over a treatment duration of 12 to 16 weeks is usually an essential part of the Phase II program.

Phase III

Phase III trials are randomized controlled multicentre trials and provide most of the long-term safety data. Phase III trials investigate the efficacy and safety of a new drug over 6 to 12 months or longer in a large patient population (several hundred patients or more) under conditions that reflect daily clinical life much more closely than the Phase I or II trials and allow evaluation of the overall benefit-risk relationship of the drug. These trials are usually conducted on an outpatient basis with no in-house days and include an active comparator, at least in the case of metabolic diseases, because exposing patients to several months of placebo treatment would not generally be ethical. Because of their size and comparatively long duration, Phase III trials are the most expensive, time-consuming and difficult trials to design and run, especially in therapies for chronic medical conditions. Therefore, drugs that do not show promising results in Phase II are often not pursued in phase III. In fact, only 25-30 % of drugs in Phase II proceed to Phase III. Phase IIIA studies are used for the approval of the drug from the appropriate regulatory agencies (known as Pivotal study). The results of these studies are included in the submission package to regulatory authorities. Between submission and approval, Phase IIIB studies are often performed to obtain additional safety data or to support publication, marketing claims (label extension) or to prepare launch for the drug.
Most drugs undergoing Phase III clinical trials can be marketed under FDA norms with proper recommendations and guidelines through a New Drug Application (NDA) containing all manufacturing, pre-clinical, and clinical data.
Drug-drug intervention (DDI) studies may be part of another large Phase 2 or Phase 3 study. However, the DDI program depends on DDI potential of the drug and should be discussed with appropriate authorities.

Phase IV

Phase IV trials are also known as post-marketing surveillance trials involving safety surveillance (pharmacovigilance) and ongoing technical support after approval. However, not all Phase IV studies are post-marketing surveillance studies. There are multiple observational designs and evaluation schemes that can be used in Phase IV studies to assess the effectiveness, cost-effectiveness, and safety of an intervention in real-world settings. Phase IV studies may be required by regulatory authorities (e.g. change in labelling, risk management/minimization action plan) or may be undertaken by the sponsoring company for competitive purposes or other reasons. This could entail the drug being tested in a certain new population (e.g. pregnant women). The safety surveillance is designed to detect any rare or long-term adverse effects over a much larger patient population and longer time period.

Equity markets have made new highs while bond markets have stalled. Economic data are mixed following months of signs of slowing. India’s economy has slowed drastically, China’s slowdown seems to have moderated, Europe still looks weak albeit the data seems to have stopped deteriorating and the US economy seems to have firmed from prior weakness. The overall picture still looks weak and the central banks have had to maintain or increase accommodation. While I was out, the Fed cut interest rates another 25 basis points and the probability that rates will not be cut further this year has risen from 60% to 80%.

Why are equities rising? The Fed continues to provide liquidity, cutting rates, and increasing repo operations as well as bond purchases, in a move it has declined to call QE, yet is practically identical to QE in form if not in detail. Share buybacks continue apace as cheap credit allows firms to raise debt to fund buybacks, increasing corporate leverage further. Bad for bond holders but good for shareholders. Lower interest rates also support higher valuations.

Why are bonds stagnating? The bond market is broader than the equity market. There are many corporate issuers without listed equity, there are mortgages, and other ABS. The weak economy is manifesting in this broad measure, while the equity market representation is shrinking.

The loan market has been an area of focus. Weaker covenants and documentation, collateral leakage, and falling short term interest rates have impacted this market. The fundamental reality is that if loans are in trouble, equities are in much worse trouble, since they are first loss. The practical reality is that technicals, that is demand from investors and ETFs, central bank liquidity, share buybacks, et al, support equity markets while falling interest rates make loans less attractive. Interest rates are an important driver of loan performance these past weeks as a comparison with HY bonds reveals. Spreads have not widened much for HY bonds, yet loan spreads have widened (suffered) more.

Where to from here? The Fed has signaled that it will be data dependent from here and has removed any language signaling a leaning towards raising or cutting rates. The momentum from the recent rate cut is still driving asset prices and the bond market but the transition from easy to neutral at the Fed is likely to take hold in the coming weeks.

Equity markets should continue to richen into the year end as central banks continue to support markets for risk assets. They will do so until they cannot and it could be some time before they run out of ammo. When they do, they will have raised valuations to even loftier levels and the correction will be steep. Until then, for the intrepid trader, momentum will carry the market.

Duration is hard to call. The Fed needed to get the inversion out of the front to 5 year end of the curve and it has nearly achieved that. Recessionary pressures from the yield curve are gone. But the curve is sufficiently flat that there is no room for flattening without inversion and recession, and there is little impetus for steepening while the Fed has resumed bond buying.\

As for EUR duration, Draghi’s swansong rate cut and QE resumption probably marked the end of the EUR duration trade for some time. Both Draghi’s and Lagarde’s concerted call for more fiscal support are a signal that either the ECB will not accelerate accommodation, or it cannot. And if fiscal support really comes, it would certainly push rates higher.