Revisiting the US-China Cold War
Since the beginning of Trump’s presidency in 2017, trade war news dominated media headlines and rocked global financial markets. Then in 2020, an unexpected pandemic overturned the world both socially and economically.
From early last year, trade issues have taken a back seat to the global health crisis while countries entered unprecedented lockdowns and enforced severe mobility restrictions. Almost a half year into 2021, as developed economies gain ground on inoculation against the novel coronavirus, many regions are looking to reopen their borders and revive their economies.
Now, with some light at the end of the healthcare crisis tunnel, governments around the world have begun revisiting their trade policies. Front and centre is the ongoing geopolitical tension between the US and China, the world’s largest two economies, and its implications for financial markets and the global economy.
During his four years of presidency, Donald Trump shocked the world by initiating a series of extreme populist policies. As Trump pulled the US out of established world organisations, took a hard stance on immigration, and imposed tariffs on allies and competing countries, investors pondered whether the world was entering an era of deglobalisation.
Then five months after President Joe Biden took office this year, the Democratic Party leader has once again changed the America’s course on climate, taxes and relations with long-term allies.
However, the tension between the US and China has not eased that much. For example, an average 19.3 per cent tariff continues to be imposed on $370 billion of annual imports from China, which is equivalent to three-quarters of total Chinese exports to the US.
Despite all of these legacy tariffs continuing to be enforced, manufacturing has not really been shifted to the US, but to other countries with cheaper labour such as India and Vietnam. As well, costs are being passed on to US consumers through higher prices. Some argue that removing tariffs now could provide a timely hedge against overheated inflation, but the US government still needs tariffs as a bargain tool to negotiate geopolitical issues.
As China’s economy continues to grow at a faster pace than the US, the power battle does not look like it will end any time soon. On the other hand, we could see a deal on the trade front given how much both sides have to gain. For example, China was the America’s largest trading partner in 2020. In fact, US exports to all its major trading partners declined last year with the exception of China, where they rose by about 10 per cent.
At the same time, China’s exports to the US in Q1 rose 62.7 per cent, while imports from the US increased by 57.9 per cent. Imports mostly increased in agricultural products, autos and auto parts, and energy. Despite the disagreements, trade between the two countries is mutually beneficial.
Back in 2015, Chinese premier Keqiang Li issued the Made in China 2025 initiative, a national strategic plan aimed at transitioning China away from being a labour-intensive world factory towards a high technology powerhouse. Chinese leaders hope that large amounts government investment in key technologies will secure the country a lead position in the Fourth Industrial Revolution. The initiative is designed to capture global market share in sectors from artificial intelligence, 5G cellular telecommunications, aerospace, semiconductors, electric vehicles to biotech.
In a bid to enhance its global leadership position, the US government has been working on the US Innovation and Competition Act. On June 8, the bipartisan US Senate passed the sweeping competition bill aimed to improve the country’s global competitiveness, especially its ability to compete against China. This legislation still needs to be approved by the House of Representatives before signed into law by the President.
As the largest investment in technological innovation in generations, the new package includes about $190 billion of funding to strengthen technology and research, in addition to $54 billion to increase production and research into semiconductors and telecommunications equipment. The bill also seeks to increase US involvement in international organisations in order to counter China’s growing global influence.
Despite US sanctions on Chinese companies and ban on a number of Chinese stocks, offshore investors have been steadily increasing their exposure to the Chinese market with foreign fund inflows into Chinese stocks rising rapidly in the past few months.
For example, China A-shares, once very difficult for non-Chinese to access, have become more mainstream. During their 2019 semi-annual index review MSCI, a leading index provider, announced it would increase its China A large cap share weighting from 5 per cent to 20 per cent in the emerging market index and other relevant indices. Additionally, the MSCI planned to add 168 China A mid-cap shares at a 20 per cent inclusion factor.
As the global healthcare crisis fades and vaccines made more widely available, investors must once again keep an eye on trade and how it could again become a major factor influencing markets.
While we may be a long way from a Cold War detente, there are reasons for optimism. Overall, we remain constructive on emerging markets including China while continuing to selectively favour previously embattled technology sectors such as semiconductors.
Bryan Dooley, CFA is Head of Portfolio Management and Nan Wang, CFA is a Portfolio Manager at LOM Asset Management Ltd in Bermuda. Please contact LOM at 441-292-5000 for further information. This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult with their Brokers if such information and or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority.