How can the US-China relationship be fixed? Victoria Mio, CIO China, and Fabiana Fedeli, Head of Fundamental Equities, met several financial leaders, government officials, and think-tank analysts from the United States and China at a US-China symposium, trying to find the answer to this question.
In the past few months, the clash of Xi’s ‘China Dream’ and Trump’s ‘Make America Great Again’ has created turmoil in the US-China relationship. Meanwhile, China is gradually opening up the domestic economy by allowing, among other things, more foreign investment in the financial sector, and is containing debt expansion via increased regulation in areas such as shadow banking and fintech. Will this be sufficient to mend the relationship with the US?
There is a significant change in the US-China relationship. Overall, the consensus among US policy makers is to take on a tougher stance. What triggered this, however, is not a worsening in China’s behavior but rather the realization of how powerful the country has become in the global context.
In the past, the US political elites held the view that as long as China integrated more into the world trade system, the Chinese economy would become more market-oriented, implying that state control would reduce, and ideologically China would draw closer to the western world. However, the consolidation of power by President Xi has changed the perception and approach of the western world towards China. The country’s size and power in the world have increased, while its ideology has not drawn closer to that of the US. The One Belt One Road (OBOR) and Made in China 2025 strategies are perceived by the US as China challenging the established world economic and political order.
The US merchandise trade deficit with China (47%) is high relative to its GDP share and the service surplus (15%) is low. However, a deeper, long-term problem needs to be evaluated: can China and the US escape the Thucydides Trap? Professor Graham Allison of Harvard Kennedy School has popularized this term to explain the likelihood of conflict between a rising power and a currently dominant one. This is based on the famous quote from ancient Greece’s historian and general Thucydides: “It was the rise of Athens and the fear that this inspired in Sparta that made war inevitable.”
The most recent trade frictions are one manifestation of how delicate the balance of power has become. The key issue is, is it at all possible for China to give President Trump what he wants? Following Vice-Premier Liu He’s trip to the US in May 2018, a joint announcement stated that China will significantly increase purchases of US goods and services and deepen cooperation on bilateral investment and intellectual property protection. However, questions remain on how China could
increase imported goods from the US by the ‘requested’ USD 200 billion without purchasing more IP-sensitive goods, which the US does not want to sell due to security concerns.
China will likely opt for a gradual shift to US products in its incremental imports, such as beef, LNG and automobiles, but this is unlikely to fill the trade deficit. Hence, the trade frictions between the two countries are more likely to drag on.
Services exports could provide a solution to the current frictions, by off-setting the trade deficit with an increase in the services surplus. Currently travel and education contribute over half of US services exports to China and growth remains strong and sustained. During our meetings, Chinese officials reaffirmed their commitment to stay on the path of liberalization and promoting globalization.
Both sides are likely to maintain a strong stance and some damage (to specific sectors in certain countries) could be caused along the way. Risks from the global macro backdrop remain. In particular, geopolitical tension such as those between China, the US, South and North Korea could affect the region.
As for North Korea, the recent Trump-Kim Jong Un summit hints to a normalization. That said, given the volatile nature of the main personalities involved, any further development needs to be monitored.
Fedeli and Mio maintain their Chinese growth forecast of 6.5% for 2018 and a positive stance on the Chinese equities markets. Growth is resilient, as consumer confidence remains strong, supported by higher income and property prices, and industrial production remains robust. Chinese corporate earnings momentum decelerated in the first quarter of this year, but remained strong at 15.6% yoy.
The stakes in a trade war are high for both countries, which means that more negotiations are likely, but the process will not be straightforward. Both President Xi and President Trump are expected to maintain a tough stance to further their domestic agendas: Xi to push through tough reforms and Trump to help his party win the mid-term elections. The market will likely focus on the potential winners or losers in the energy, auto and tech hardware spaces. Should a trade war truly escalate, the Chinese government is expected to loosen policies somewhat in order to hedge downside risks.