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Our latest podcast deep-dives into the recent empirical results in relation to corporate diversification, with a special emphasis on both the bright and dark sides of internal capital markets. The bright-side view posits that internal capital markets benefit from stronger control rights and fewer information asymmetries across intra-firm divisions while this benefit in turn enables the CEO to make better fund allocation decisions. In contrast, the dark-side view suggests that internal capital markets suffer from the agency motives of both divisional managers and the CEO who might prefer to pursue their private interests. Several recent empirical studies delve into the delicate balance between the bright and dark sides of internal capital markets.

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The original blog article is available on our AYA fintech network platform. https://ayafintech.network/blog/corporate-diversification-theory-and-evidence/

This fun podcast is about 10 minutes long (with smart AI podcast generation from Google NotebookLM). https://bit.ly/4hhxUMf

A recent strand of corporate diversification literature spans at least three generations. The first generation suggests that corporate diversification typically erodes firm value. The entire firm value is less than the sum of the imputed values of different segments. The diversification discount is 12%-15% of Tobin’s q (e.g. Lang and Stulz (1994) and Berger and Ofek (1995)). Also, the second generation suggests that the diversification discount is at least partly attributable to the use of anti-takeover provisions, which insulate incumbents from the direct influence of hostile takeovers and hence result in poor corporate governance (Hoechle, Schmid, Walter, and Yermack, 2012). Finally, the third generation sheds fresh light on the role of internal capital markets that help transfer valuable capital from one division to another division within the same enterprise (e.g. Duchin (2010) and Duchin and Sosyura (2013)). Both the bright and dark sides of internal capital markets warrant attention from corporate decision-makers.

Lang and Stulz (1994) empirically find that corporate diversification erodes firm value. The typical firm decides to diversify into some other industry segments when there are few internal investment growth opportunities. On average, the firm diversification discount is about 12%-15% of Tobin’s q. Furthermore, Berger and Ofek (1995) report that the diversification discount is much smaller when this diversification occurs in somewhat related industry segments at the 2-digit SIC codes. Also, overinvestment and cross-subsidization contribute to the loss of firm value that arises from corporate diversification.

More recent empirical studies suggest that firm diversification occurs endogenously in response to both corporate value and governance (Campa and Kedia, 2002; Graham, Lemmon, and Wolf, 2002; Villalonga, 2004). Valid instruments are the lags of firm performance, corporate governance, and several other firm attributes (Wintoki, Linck, and Netter, 2012). In the special case of both international and U.S. financial conglomerates, Laeven and Levine (2007) and Schmid and Walter (2009) empirically find an increase in the diversification discount when the econometrician uses the Heckman (1979) sample selection model to account for any self-selection bias that may arise from corporate diversification.

Hoechle, Schmid, Walter, and Yermack (2012) investigate whether the diversification discount occurs as an artifact of poor corporate governance. A number of dynamic panel regressions adequately control for potential endogeneity of the typical firm’s diversification decision. The diversification discount shrinks by a full order of magnitude with the addition of governance variables such as anti-takeover provisions to the dynamic panel regressions. Differences in the quality of corporate governance across conglomerate firms can help explain at least part of the negative nexus between firm value and corporate diversification. Specifically, Hoechle, Schmid, Walter, and Yermack’s (2012) baseline panel regression model suggests that the diversification discount decreases from 15%-17% to about 13% when the econometrician adds a plethora of corporate governance variables such as institutional ownership, CEO stock ownership and its square, CEO power, and G-index of anti-takeover provisions to the panel regressions of excess value multiples to total sales or total assets with firm-specific fixed effects. If poorly governed firms often tend to diversify, perhaps through mergers, acquisitions, and overinvestments in somewhat unrelated industry segments, then the diversification discount could be the symptom of a larger problem in the fundamental context of corporate governance.

Hoechle, Schmid, Walter, and Yermack (2012) follow Campa and Kedia’s (2002) treatment of potential endogeneity by implementing the Heckman (1979) sample selection model to reassess the diversification discount. The Heckman method involves a two-step procedure that uses a probit model for the subsequent analysis of discount determinants. The econometrician first estimates the firm’s propensity to diversify with a probit model via quasi-maximum likelihood estimation. The inverse Mills ratio can be computed as the hazard rate of the probability density function (pdf) to the cumulative density function (cdf) from the first-step probit estimation. In turn, this ratio serves as an auxiliary explanatory variable in the second-step regression of excess firm value on a unique set of firm attributes. The resultant parameters would be consistent with the true counterparts (Heckman, 1979).

A firm’s current actions affect its future corporate governance and firm performance, the latter of which then affects the firm’s future actions (e.g. Hermalin and Weisbach (2004) and Wintoki, Linck, and Netter (2012)). In order to address the dynamic endogeneity issue, Hoechle, Schmid, Walter, and Yermack (2012) run the GMM panel regression model that corresponds to a dynamic system of simultaneous equations. The first step involves the inclusion of performance lags as explanatory variables in the dynamic model. The econometrician first-differences each factor to remove any unobservable heterogeneity and omitted-variables bias. Then the econometrician estimates the GMM panel regression model with the use of lags of the diversification, governance, and performance variables as well as some other firm characteristics as exogenous instruments.

While the Heckman (1979) sample selection model suggests that the diversification discount vanishes as a result of adding corporate governance variables to the set of explanatory variables, the dynamic GMM panel regressions produce a smaller but still significant diversification discount. Specifically, the GMM estimate of diversification discount decreases from 12% (t-ratio>2) to 7.6% (t-ratio<2) with the addition of corporate governance variables. Overall, poor corporate governance helps explain at least part of the corporate diversification discount.

Masulis, Wang, and Xie’s (2007) event study suggests that merger announcement returns are significantly lower for acquirers with poor corporate governance structures (e.g. more anti-takeover provisions in the market for corporate control). Specifically, acquirers with more anti-takeover provisions or joint CEO-chairman positions experience significantly lower merger-announcement cumulative abnormal returns. In order to evaluate whether the diversification discount decreases with better corporate governance in merger and acquisition announcements, Hoechle, Schmid, Walter, and Yermack (2012) add the same set of governance variables plus the diversification dummy variable to the panel regressions of post-merger announcement cumulative abnormal returns within short time windows. The main evidence suggests that the negative cumulative abnormal return for corporate diversification decreases from nearly 1.2%-1.6% (t-ratio>2) to 0.3%-0.6% (t-ratio<2). This event study echoes the overarching thesis of the dynamic panel regression results that poor corporate governance helps explain at least part of the diversification discount.

A major implication of corporate diversification pertains to the precautionary demand for cash retention. According to the precautionary cash demand story (Keynes, 1936), firms hold cash to protect themselves against adverse cash flow shocks that might force these firms to forego valuable investment opportunities due to costly external finance. Some recent empirical studies of structural shifts in corporate cash reserves lend credence to the central thesis that firms increasingly hold cash for a precautionary motive while the median firm’s net debt (i.e. total debt minus cash) is below zero (Opler, Pinkowitz, Stulz, and Williamson, 1999; Almeida, Campello, and Weisbach, 2004; Bates, Kahle, and Stulz, 2009).

Well-diversified firms exhibit lower cross-divisional correlations in investment opportunities and smaller financing deficits (Duchin, 2010). These well-diversified firms enjoy the benefit of coinsurance, which reduces their exposure to risk and allows them to hold lower amounts of precautionary cash in contrast to their standalone counterparts. Multi-divisional firms hold approximately half as much cash as highly specialized firms do. The difference is largely due to corporate diversification in investment opportunities and cash flows. Well-diversified firms hold low precautionary cash balances, which in turn reflect sound governance and efficient fund transfer within these firms.

Duchin and Sosyura (2013) draw a clear distinction between the bright and dark sides of internal capital markets. The bright-side view posits that internal capital markets benefit from stronger control rights and fewer information asymmetries across intra-firm divisions while this benefit in turn enables the CEO to make better fund allocation decisions (e.g. Naveen and Tice (2001) and Maksimovic and Phillips (2002)). In contrast, the dark-side view suggests that internal capital markets suffer from the agency motives of both divisional managers and the CEO who might prefer to pursue their private interests (Scharfstein and Stein, 2000; Rajan, Servaes, and Zingales, 2000; Ozbas and Scharfstein, 2009). The relative importance of divisional managers garners practical support from the survey evidence of Graham, Harvey, and Puri (2015) who report that the CEO’s opinion of a divisional manager is the second most important factor in internal capital allocation after the net present value rule.

Duchin and Sosyura (2013) offer evidence on the watershed between the bright and dark sides of internal capital markets by constructing a hand-collected dataset of divisional managers at S&P 500 firms with managerial attributes and connections to the CEO on capital allocation decisions. In particular, Duchin and Sosyura (2013) evaluate the involvement of divisional managers in the firm via various channels, ranging from formal board membership and seniority to informal social connections to the CEO via prior employment, educational institutions, and non-profit organizations. The evidence suggests that divisional managers with social connections to the CEO receive more capital after the econometrician controls for divisional size, performance, proxies for investment opportunities, and other characteristics. One social connection between a divisional manager and the CEO correlates with 7.2% greater capital allocation to his or her division or about $4.2 million in annual expenditure in a division with median characteristics.

At well-governed firms with high information asymmetries, where divisional managers are likely to have valuable information about investment opportunities, social connections between the CEO and divisional managers significantly correlate with better investment efficiency and firm valuation. In contrast, at firms with poor governance, which are more prone to agency-driven favoritism, managerial connections to the CEO are negatively related to investment efficiency and firm value. Duchin and Sosyura’s (2013) study draws a clear empirical distinction between the bright and dark sides of internal capital markets. In this light, corporate diversification results in some costs and benefits that must be weighed against managerial connections to the CEO in different contexts.

With U.S. fintech patent approval, accreditation, and protection for 20 years, our AYA fintech network platform provides proprietary alpha stock signals and personal finance tools for stock market investors worldwide.

We build, design, and delve into our new and non-obvious proprietary algorithmic system for smart asset return prediction and fintech network platform automation. Unlike our fintech rivals and competitors who chose to keep their proprietary algorithms in a black box, we open the black box by providing the free and complete disclosure of our U.S. fintech patent publication. In this rare unique fashion, we help stock market investors ferret out informative alpha stock signals in order to enrich their own stock market investment portfolios. With no need to crunch data over an extensive period of time, our freemium members pick and choose their own alpha stock signals for profitable investment opportunities in the U.S. stock market.

Smart investors can consult our proprietary alpha stock signals to ferret out rare opportunities for transient stock market undervaluation. Our analytic reports help many stock market investors better understand global macro trends in trade, finance, technology, and so forth. Most investors can combine our proprietary alpha stock signals with broader and deeper macrofinancial knowledge to win in the stock market.

Through our proprietary alpha stock signals and personal finance tools, we can help stock market investors achieve their near-term and longer-term financial goals. High-quality stock market investment decisions can help investors attain the near-term goals of buying a smartphone, a car, a house, good health care, and many more. Also, these high-quality stock market investment decisions can further help investors attain the longer-term goals of saving for travel, passive income, retirement, self-employment, and college education for children. Our AYA fintech network platform empowers stock market investors through better social integration, education, and technology.

Our latest podcast deep-dives into the recent empirical results in support of the mainstream choices, reasons, and decisions for corporate cash management.

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#size #value #momentum #profitability #assetgrowth #marketrisk #revenuegrowth #residualvariance #industry 

#accrual #issuance #dividendyield #fibonacci #bollinger #murphyrank #shortrange #longrange #macd #rsi 

The original blog article is available on our AYA fintech network platform. https://ayafintech.network/blog/corporate-cash-management/

This fun podcast is about 10 minutes long (with smart AI podcast generation from Google NotebookLM). https://bit.ly/3CrZEyz

The empirical corporate finance literature suggests four primary motives for firms to hold cash. These motives include the transaction motive, the tax motive, the agency motive, and the precautionary demand motive. Most classical models derive the optimal demand for cash when a firm incurs transaction costs that arise from the conversion of a non-cash asset into cash (Baumol, 1952; Miller and Orr, 1966; Mulligan, 1997). Since there are economies of scale with the transaction motive, large firms often appear to hold less cash. In addition to the transaction motive, the tax motive is another primary concern. Firms that would incur tax consequences of foreign income repatriation often hold more cash (Foley, Hartzell, Titman, and Twite, 2007). As a result, multinational firms are more likely to hoard cash for legitimate tax avoidance.

Bates, Kahle, and Stulz (2009) establish a clear distinction between the agency and precautionary demand stories of corporate cash management. According to the agency story, entrenched managers would rather retain cash than disgorge cash payout to shareholders when the firm has subpar investment opportunities (Jensen, 1986). Several recent empirical studies provide at least partial support for this agency story (e.g. Dittmar, Mahrt-Smith, and Servaes (2003), Pinkowitz, Stulz, and Williamson (2006), Dittmar and Mahrt-Smith (2007), and Harford, Mansi, and Maxwell (2008)). In contrast to the agency story, the alternative precautionary cash demand story suggests that firms hoard cash to better cope with adverse shocks when it is costly to access capital markets. Firms with risky cash flows and poor access to external capital hold more cash (Opler, Pinkowitz, Stulz, and Williamson, 1999). Some theoretical models further support the nexus between financial constraints and cash reserves (e.g. Acharya, Almeida, and Campello (2007) and Riddick and Whited (2009)).

Bates, Kahle, and Stulz (2009) empirically investigate how the cash stockpiles of U.S. firms have evolved since 1980 and whether this evolution can be explained by changes in the determinants of cash reserves. The average cash-to-assets ratio for American firms has more than doubled from 1980 to 2006. In terms of the economic importance of this trend, the average firm can retire all the debt obligations with its cash stockpiles. The cash-to-assets ratio increases because the typical firm’s cash flows have become riskier. The typical firm retains fewer inventories and accounts receivables and tends to be more R&D-intensive. Share issuance has become an increasingly important source of cash for firms with precautionary motives due to large R&D expenditures and volatile cash flows. Precautionary motives dominate agency conflicts in explaining the increase in the cash-to-assets ratio.

A plausible explanation for the secular increase in cash reserves for non-dividend payers pertains to the precautionary demand for cash: firms hoard cash as a buffer to insulate against adverse shocks. A well-known empirical fact is that idiosyncratic risk has substantially increased over time (Campbell, Lettau, Malkiel, and Xu, 2001). The average cash ratio increases by less than 50% for firms with the smallest increase in idiosyncratic risk but by almost 300% for firms with the largest increase in idiosyncratic risk. This increase in cash intensity closely relates to the joint themes of disappearing dividends and new stock exchange lists with more volatile cash flows (Fama and French, 2001, 2004; DeAngelo, DeAgnelo, and Skinner, 2004). Ceteris paribus the average cash-to-assets ratio increases by more than 2% from 1980 to 2006 due to the increase in cash flow volatility (cf. the precautionary demand for cash) while the average cash-to-assets ratio is 23.2% in 2006.

Bates, Kahle, and Stulz (2009) present persuasive descriptive statistics in support of the secular increase in cash intensity from 1980 to 2006. The increase in cash-to-assets is not driven by the largest firms, and is more pronounced in smaller firms. This trend is robust to IPO issuance, dividend status, and operating performance. Firms become less likely to pay dividends and thus are inclined to hoard more cash (Fama and French, 2001). Non-dividend payers with fewer investment opportunities appear to accumulate more cash (Jensen, 1986). While these descriptive statistics seem to highlight the agency story as the smoking gun, financial constraint risk can be an equally plausible explanation for the secular increase in corporate cash intensity (Almeida, Campello, and Weisbach, 2004). Because financial constraints induce the firm to save cash out of cash flows (cf. the cash flow sensitivity of cash), financially constrained firms should face a positive cash flow sensitivity of cash while unconstrained firms do not face any systematic relation between cash reserves and cash flows.

Bates, Kahle, and Stulz (2009) cleverly find the Achilles heel in the central prediction of the agency story: entrenched managers are likely to retain free cash flows without significant payout to shareholders, thus the agency story predicts a higher increase in cash-to-assets in the top G-index quintile with more anti-takeover provisions (Gompers, Ishii, and Metrick, 2003). Yet, Bates, Kahle, and Stulz’s (2009) empirical results contradict this prediction. While each G-index quintile experiences an increase in the mean cash-to-assets ratio, this increase is more pronounced for the lower G-index quintiles. Also, firms that land in the highest G-index quintile with the highest level of managerial entrenchment hold the least amount of cash. This evidence shoots a straight shot at the heart of the agency hypothesis and instead supports the alternative story of precautionary demand for cash.

Bates, Kahle, and Stulz (2009) regress each firm’s market value on a unique set of explanatory variables such as cash stockpiles and their interactions with binary decade variables. A higher mean cash-to-assets ratio correlates with higher firm valuation. The average cash-to-assets ratio positively interacts with the binary decade variables, so the increase in cash reserves contributes to higher firm valuation over time. This evidence refutes the central prediction of the agency story that the value of cash stockpiles declines when the firm accumulates more free cash flows over time. Bates, Kahle, and Stulz’s (2009) empirical thesis differs from a recent strand of corporate cash management literature that investors in regimes with poor governance cannot induce incumbents to disgorge cash balances while firms with weak governance dissipate excess cash flows more quickly than firms with robust governance (Dittmar, Mahrt-Smith, and Servaes, 2003; Pinkowitz, Stulz, and Williamson, 2006; Dittmar and Mahrt-Smith, 2007).

Harford, Mansi, and Maxwell (2008) study how agency problems affect the typical firm’s propensity to stockpile cash reserves (Jensen and Meckling, 1976; Jensen, 1986). Specifically, Harford, Mansi, and Maxwell (2008) analyze the empirical nexus between corporate governance structures and cash reserves and its implications for corporate investment, payout, and firm value. Firms with weaker governance (i.e. more anti-takeover provisions and lower incumbent equity stakes) hoard smaller cash reserves because entrenched managers tend to spend cash quickly on M&A activities and capital expenditures. Also, firms with weaker governance metrics choose to repurchase stock rather than increase dividend payout. Lastly, excess cash correlates with lower firm value, thus most of the cash-led M&A and capital overinvestments are suboptimal. Harford, Mansi, and Maxwell’s (2008) empirical study offers an ingenious resurrection of the agency story of managerial entrenchment and excess cash utilization.

Jensen (1986) and Stulz (1990) develop the free cash flow hypothesis and then predict that shareholders choose to limit managerial access to free cash flow to mitigate agency conflicts. Shareholders assign a lower value to an additional dollar of cash reserves when agency problems are likely to be more severe at the firm (Dittmar and Mahrt-Smith, 2007). Cross-country evidence suggests that greater shareholder rights tend to correlate with lower cash stockpiles (Dittmar, Mahrt-Smith, and Servaes, 2003). Beyond the main prediction of the agency hypothesis, firms often hoard cash due to a precautionary motive (Opler, Pinkowitz, Stulz, and Williamson, 1999; Bates, Kahle, and Stulz, 2009).

Harford, Mansi, and Maxwell (2008) focus on the spending hypothesis: self-interested incumbents prefer firm expansion and thus spend excess cash flows when this cash resource becomes available (Jensen and Meckling, 1976). When incumbents hoard excess cash stockpiles, these incumbents often tend to quickly use up cash reserves in capital expenditures or mergers and acquisitions. Harford, Mansi, and Maxwell (2008) assess whether weak corporate governance structures with more G-index or E-index anti-takeover provisions and lower insider equity stakes interact with cash reserves in exacerbating the agency conflict between incumbents and shareholders.

Firms with high G-indices or E-indices have lower stock market values ceteris paribus (Gompers, Ishii, and Metrick, 2003; Bebchuk, Cohen, and Ferrell, 2009). Also, firms with more G-index or E-index anti-takeover provisions experience a deterioration in operating performance in contrast to firms with fewer anti-takeover provisions (Core, Guay, and Rusticus, 2006). Furthermore, high G-index firms often suffer substantial shareholder wealth losses on M&A announcements (Masulis, Wang, and Xie, 2007). Another governance metric is corporate insider stock ownership. High insider ownership may help mitigate the free-rider problem in monitoring management in search of less managerial opportunism (Shleifer and Vishny, 1986). Alternatively, this ownership concentration can act to promote self-interest on the part of corporate incumbents (Shleifer and Vishny, 1997).

Harford, Mansi, and Maxwell (2008) follow Opler, Pinkowitz, Stulz, and Williamson (1999) to include a variety of control variables to isolate the effect of both prior cash and governance metrics on subsequent cash-to-assets. These control variables include firm size, leverage, market-to-book, cash-flow-to-assets, 10-year cash flow volatility, net-working-capital-to-assets, R&D-to-sales, capital-expenditure-to-assets, M&A-expenditure-to-assets, dividend payout, and bond rating availability. Harford, Mansi, and Maxwell (2008) report that cash resources are positively related to the quality of corporate governance: firms with better governance hoard relatively more cash (conversely, firms with weaker governance hoard relatively less cash). Specifically, cash reserves are negatively related to the G-index that measures the number of anti-takeover provisions for a given firm. In addition, cash reserves are positively related to insider equity stakes that serve as another proxy for the severity of agency conflicts between managers and shareholders. These empirical results are robust to a variety of alternative specifications with different control variables.

Harford, Mansi, and Maxwell (2008) report evidence in support of the spending hypothesis: firms with better corporate governance tend to spend excess cash on M&A, capital investment, and dividend payout. The interaction between high G-indices and cash reserves suggests that this propensity to increase M&A and capital investment is greater in the presence of excess cash (Harford, 1999; Masulis, Wang, and Xie, 2007). Firms with more excess cash increase their dividend distributions and so commit to higher payouts in the long run. In contrast, firms with weak governance choose to repurchase stock with no commitment to maintaining future dividend streams. Harford, Mansi, and Maxwell’s (2008) empirical study serves as an ingenious resurrection of the agency story of managerial entrenchment and excess cash utilization.

Gao, Harford, and Li (2013) note that there are fundamental differences in the determinants of corporate cash decisions between public and private firms. In comparison to public firms, private firms experience a faster speed of adjustment toward the target cash-to-assets ratio (i.e. it takes about 8 years for the typical private firm to close the wedge between the target cash ratio and the status quo). Relative to public firms, private firms face less severe agency conflict, better investment quality (higher R&D intensity and ROA), and lower leverage. This agency difference helps explain why on average private firms retain about half as much cash as public firms do. In sum, Gao, Harford, and Li’s (2013) empirical results suggest that the agency issue affects not only the relative level of corporate cash retention but also how incumbents react to cash in excess of the target cash-to-assets ratio.

With U.S. fintech patent approval, accreditation, and protection for 20 years, our AYA fintech network platform provides proprietary alpha stock signals and personal finance tools for stock market investors worldwide.

We build, design, and delve into our new and non-obvious proprietary algorithmic system for smart asset return prediction and fintech network platform automation. Unlike our fintech rivals and competitors who chose to keep their proprietary algorithms in a black box, we open the black box by providing the free and complete disclosure of our U.S. fintech patent publication. In this rare unique fashion, we help stock market investors ferret out informative alpha stock signals in order to enrich their own stock market investment portfolios. With no need to crunch data over an extensive period of time, our freemium members pick and choose their own alpha stock signals for profitable investment opportunities in the U.S. stock market.

Smart investors can consult our proprietary alpha stock signals to ferret out rare opportunities for transient stock market undervaluation. Our analytic reports help many stock market investors better understand global macro trends in trade, finance, technology, and so forth. Most investors can combine our proprietary alpha stock signals with broader and deeper macrofinancial knowledge to win in the stock market.

Through our proprietary alpha stock signals and personal finance tools, we can help stock market investors achieve their near-term and longer-term financial goals. High-quality stock market investment decisions can help investors attain the near-term goals of buying a smartphone, a car, a house, good health care, and many more. Also, these high-quality stock market investment decisions can further help investors attain the longer-term goals of saving for travel, passive income, retirement, self-employment, and college education for children. Our AYA fintech network platform empowers stock market investors through better social integration, education, and technology.

Our latest podcast deep-dives into why President Trump continues to blame China for the long prevalent U.S. trade deficits and several other social and economic deficiencies as he moves into his second term.

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$META $AAPL $MSFT $AMZN $GOOG $GOOGL $TSLA $NIO $RIVN $CSCO $ASML $ORCL $IBM $PYPL 

$PLTR $KO $MCD $WMT $TGT $COST $YUM $DOCU $EXE $XOM $COP $CVX $OXY $PSX $BP $SLB 

#size #value #momentum #profitability #assetgrowth #marketrisk #revenuegrowth #residualvariance #industry 

#dividendyield #issuance #accrual #bollinger #murphyrank #fibonacci #shortreversal #longreversal #macd 

The original blog article is available on our AYA fintech network platform. https://ayafintech.network/blog/president-trump-blames-china-for-the-long-prevalent-us-trade-deficits-and-other-social-and-economic-woes/

This fun podcast is about 10 minutes long (with smart AI podcast generation from Google NotebookLM). https://bit.ly/42ucDKt

In recent years, President Donald Trump blames China for the long prevalent high U.S. trade deficits against the middle kingdom. Now China seems to hollow out the American industrial homeland from smartphones and semiconductor microchips to electric vehicles (EV), drones, high-speed broadband networks, cloud services, and even large language models (LLM) for generative artificial intelligence. President Trump further blames China for causing the Covid pandemic crisis worldwide. Also, President Trump accuses China of attacking the U.S. and its western allies with fentanyl in the current opioid crisis. Given his U.S. domestic economic protectionism, President Trump seeks to double down on the hardline trade war with China. Specifically, President Trump seeks to impose hefty tariffs, export restrictions, and indefinite bans on many foreign investment categories against China. As President Trump moves into his second term, he continues to view China as a geopolitical adversary in a zero-sum game. In order to make America great again, many supporters seem to think only President Trump and his hardcore cabinet members can come up with hardline economic policies, sanctions, and regulations to tame the respective foes and rivals in Beijing. Political tensions between the U.S. and China continue to persist and even exacerbate in recent years. As a result, the bilateral relations between the U.S. and China seem to rest on flimsy foundations. Nowadays, geopolitical alignment often reshapes and reinforces asset market fragmentation in the wider context of financial deglobalization. Around the world, several western governments seek to incorporate new elements of global resilience into economic statecraft.

In China, President Xi Jinping and his cabinet members may not view the new Trump second term with fear and trepidation. These Chinese leaders, technocrats, and diplomats already learned much from the Trump first term, the Biden administration, and the populist return of Donald Trump to the White House in recent years. President Trump tends to apply economic protectionism across many industrial sectors and categories with fresh geopolitical tensions and frictions on the global stage. Early in his second term, President Trump declares retreats from the international Paris climate agreement, Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), and even the World Health Organization (WHO). In effect, these complete withdrawals highlight the fact that the new Trump administration tends to undertake unilateral measures in support of greater economic protectionism in America. Despite the growing trade tensions, disputes, and frictions between Beijing and Washington, the Xi administration still seeks to navigate new confrontations in global trade, finance, and technology. Also, the new Trump administration may impose new tariffs and other economic sanctions on Canada, Mexico, and some other western allies. This hardline approach would encourage many countries, such as France, Germany, Japan, and Australia, to hedge their foreign investment bets outside North America. Specifically, these countries may choose to build better ties with Beijing, partly through its Belt-and-Road Initiative, in response to greater economic policy uncertainty in Washington. Although the U.S. and China may inadvertently stumble into the proverbial Thucydides trap, we believe the best likelihood of military threats between these dual superpowers remains quite low. Over the past decade, President Trump has not shown any deep and extreme ideological inclinations. It does not seem likely for the current competition between the U.S. and China to further escalate into a more destructive New Cold War. Although President Trump sees more realism in the current balance of power between the U.S. and China, he strives to stop-and-prevent wars in the hot and lofty pursuit of world peace. In recent years, President Trump has reiterated his intentions to coordinate truces, ceasefires, and peaceful resolutions of the relentless Russia-Ukraine war in Eastern Europe, as well as the current conflicts between Israel and Iran, Lebanon, Hamas, and the Palestinians in the Middle East. The new Trump administration seeks to better contain China, its recent rise on the global stage of economic growth, and endless interference over Taiwan along the Pacific first island chain.

Beijing believes Trump’s presidential election victory has little or minimal influence over the near-term trajectory of U.S. foreign policies toward China. In U.S. Congress, the bipartisan consensus perceives China as a unique series of new economic, technological, military, and diplomatic threats to the U.S. and its western allies, regardless of who wins the presidential bid to enter the White House. To the extent that the U.S. seeks to further contain-and-derisk from China, Russia, Iran, and North Korea, geopolitical alignment reshapes and reinforces asset market fragmentation in the broader context of financial deglobalization. Through U.S. political history, not everything remains the same from one administration to another. During his second term, President Trump is likely to maintain the hardline approach to foreign affairs with China not only from his own first term, but also from the Biden administration. President Trump seems to have learned from his first term that the current hardline approach to China would need to refresh with new and much younger cabinet members, such as Secretary of State Marco Rubio and Secretary of Defense Peter Hegseth, both of whom serve as China hawks with strong anti-communist beliefs. The devil is in the details. President Trump needs more nuance in the new bilateral relations between the U.S. and China. This nuance directs President Trump’s nominations for foreign policy and national security positions away from right-wing extremists (who served in their rightful capacity in the first Trump administration). In support of calm and stable asset markets, President Trump picks new cabinet members as strategic partners who can help advise on a wide range of global economic, technological, military, and diplomatic themes and issues during the recent rise of China, Russia, Iran, and North Korea on the global stage. Many of the new cabinet members continue to view China as the primary threat to the U.S. with substantial economic and technological advancements. For this reason, these cabinet members tend to favor new hardline and coercive measures for the new Trump administration to constrain China’s sphere of influence. Unlike the former Soviet Union in the Cold War era, China retains virtually no or few global ambitions to expand its communist propaganda. Nonetheless, the Trump administration needs to remain careful and cautious toward China’s increasingly aggressive policy stances toward Taiwan, Japan, Hong Kong, South Korea, and other strategic partners in East Asia.

In the wider geopolitical context, the same hardline approach may not work well because so much has changed significantly since the first Trump administration. When President Trump entered the White House for the first time in early-2017, many governments thought Trump would serve like a conventional American leader, an ideologically neutral businessman, and an economically rational decision-maker. Indeed, many major western allies thought Trump would commit to their common prosperity and regional security worldwide. President Trump visited China, Vietnam, South Korea, and the Philippines in November 2017. Despite U.S. opposition to Russia’s annexation of Crimea from Ukraine back in 2014, the Kremlin invited President Trump to Moscow for Russia’s annual celebration of the victory in World War II in late-2017. Subsequently, President Trump met with Russian President Vladimir Putin in a summit in Helsinki, Finland, as part of a weeklong trip to Europe in July 2018.

This time may be a bit different. Many leaders and governments are now proactive to protect their own countries from substantial economic policy uncertainty in Washington as President Trump moves into his second term. French President Emmanuel Macron invited President Trump to visit Paris as Macron would like to indicate that Europeans are their own decision-makers with respect to their own common prosperity, security, and climate risk management. Also, Japan and Germany reiterate their current concern that President Trump may require bigger fractions of their respective fiscal budgets to guarantee American military protection in their countries. In South Korea, the interim government worries that President Trump may take advantage of its current lack of authority over domestic affairs to the detriment of many special interest groups. In Taiwan, the extant government further fears that President Trump may tap into more than 5% of its annual economic output in return for U.S. military presence in response to China’s constant aggression.

In Eastern Europe, President Trump needs to grapple with the fact that Russia continues to attack Ukraine even though the U.S. and its western allies provide military support to Kiev. In the Middle East, Washington continues to provide military aid and geopolitical support for Israel’s brutal and bloody operations in Gaza, where many mainstream pundits believe there is an ongoing humanitarian crisis. Specifically, this crisis has further exposed the hypocrisy of U.S. claims to champion international law, world peace, and human rights. In his second term, President Trump has to better coordinate truces, ceasefires, and peaceful resolutions of these regional wars and conflicts in the lofty pursuit of world peace. Indeed, these peaceful resolutions can be a good legacy for President Trump to leave behind in his second term.

Since the first Trump administration, Beijing has become more adept at managing its current competition with Washington. We can trace this competition to the Obama administration in 2010 when President Obama embarked on a strategic pivot to Asia. In the subsequent years, Beijing has successfully navigated the different foreign-policy strategies and paradigms of the Obama, Trump, and Biden administrations. Both Biden and Obama attempted to contain China through multilateral negotiations, engagements, and approaches, while Trump took a more unilateral foreign policy stance toward China. With a decade-long experience, Chinese leaders remain calm, careful, and cautious toward the same well-known prospect of a Trump second term. On some of its official government agency websites, Beijing has even released strategic guidelines on how their leaders, technocrats, and diplomats can handle President Trump’s harsh foreign-policy measures against China. The Xi administration adheres to the current commitment to mutual respect, peaceful co-existence, and win-win cooperation as the mainstream principles for China-U.S. relations in trade, finance, and technology. Mutual respect refers to the worst-case scenario where China may retaliate by offloading more than $750 billion massive stockpiles of U.S. government bonds against any provocative foreign-policy measures, export restrictions, tariffs, quotas, embargoes, and several other economic sanctions that the new Trump administration chooses to undertake against China. Peaceful co-existence reflects the fact that China seeks to engage President Trump and his reps in new mutual dialogues to better manage expectations, differences, and even conflicts. In this fashion, the ultimate peaceful resolutions would help stabilize China-U.S. relations. Win-win cooperation refers to joint collaboration on global themes and issues in which China and the U.S. share common interests. In the meantime, these global themes and issues include the peaceful resolutions of wars and conflicts in Eastern Europe and the Middle East, as well as bilateral rules and regulations for artificial intelligence infrastructure, semiconductor micro-chip design, and the worldwide flow of illicit drugs (specifically, fentanyl and ketamine).

President Trump seems intent on further entrenching U.S. domestic economic protectionism in his second term, especially when this hardline foreign policy stance involves bilateral trade with China. President Trump has indicated that he might levy higher tariffs on Chinese goods. Also, the Trump administration seeks to impose more draconian restrictions on U.S. foreign direct investments (FDI) in China as well as on Chinese capital in the U.S. stock market. In addition, the Trump administration plans to place more constraints on China-U.S. high-tech collaboration with substantially fewer Chinese students and H1-B workers in the U.S. across STEM subjects. These decisions may inadvertently result in greater frictions between Beijing and Washington. Although the Biden administration extended the tariffs that Trump imposed on Chinese goods in his first term, this extension focused on excluding China from the global supply chains for intermediate technological goods, such as semiconductor microchips and high-speed broadband networks etc. Specifically, the Biden administration sought to de-risk from China, but did not seek to completely decouple from China. Throughout Biden’s tenure, key traditional trade sectors between China and America continued business-as-usual even though their technological collaboration came to a halt. In his second term, President Trump is likely to push harder for further decoupling from China. His new industrial homeland policy stance toward China may dramatically reduce the total market share of Chinese products in America. This reduction spans intermediate goods made and built outside China; however, their lean production still relies heavily on Chinese investments, factories, components, and other industrial resources. At the same time, Beijing may retaliate by offloading at least some of the $750 billion massive stockpiles of U.S. government bonds, as well as $2 trillion dollar assets, against any provocative foreign-policy measures, export restrictions, tariffs, quotas, embargoes, and some other economic sanctions that the new Trump administration deploys against China. This tit-for-tac dynamism may drive the China-U.S. trade war to a new peak. As a consequence, the global economy would suffer with new scars and damages as many other countries scramble to implement their own protectionist policies in global trade, finance, and technology.

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