“The United States isn’t qualified to speak to China from a position of strength,” were the words of American relationship specialist and high-ranking Politburo member Yang Jiechi at the 2021 US-China talks in Alaska. Jiechi’s statement embodies Beijing’s view that China is a fellow superpower to the US and is vying for dominance. China's meteoric rise to become the world's second-largest economy in 2010, its growing importance as a trading partner globally, and its spiralling circle of influence, supports this view.
The world’s two economic superpowers have become increasingly intertwined. For example, China’s share of US goods imports expanded from 9.8% in 2001 to 18.1% in 2019, and imports of services rose from 3.3% to 8.1% during the same period. Despite growing trade, the relationship between Beijing and Washington might be at the most strained it has been, and both governments are attempting to “decouple”. President Biden’s campaign focused on “Made in America,” prioritising reducing reliance on Chinese supply lines. Meanwhile, President Xi has touted “Dual Circulation” that emphasises increased self-reliance in critical industries, such as food and technology. With both countries looking to decouple partially, what do investors need to know about the US-China relationship?
China actively uses fiscal policy to subsidise and nurture nascent industries until they are strong enough to compete with world powers. Advanced economies have accused these subsidies of rendering an unfair advantage. In specific sectors, subsidies have recently been extended to foreign firms, attracting foreign operations. Tesla's earnings, for example, have significantly benefited from the Chinese emission credit system.
Also, domestic industrial activity in the Asian dragon is buoyed by cheap labour, energy costs, and lax environmental controls, making China a popular reshoring hub and an attracter of polluting industries. China, for example, covers 80% of US rare earth demand but uses the highly polluting process of In-situ Leaching, which is prohibited in most advanced economies.
To reduce Chinese competitiveness, President Trump imposed tariffs on $360 billion worth of imports from China, provoking $1,110 billion of retaliatory tariffs from Beijing. Chinese output responded with resilience. While exports to the US fell in 2019, China's exports globally grew during every year of the Trump presidency. China has been shifting its target market to the growing South East Asian economies, with ASEAN overtaking the US as China’s primary trading partner in 2019. In 2020, Chinese recovery helped sustain the world commodity markets, and rebounding exports helped fulfil global demand recovery in the second half of the year.
An NBER report showed that the tariffs lead to an income loss of $16.8 billion in 2018. Manufacturing job growth in the US also stalled post tariffs. While tariffs did improve the competitiveness of US manufactured goods, higher costs of imports of inputs from China offset the positives. Investors can expect continued headwinds on the US manufacturing sector from the ongoing reshoring to China and from higher input prices. Firms that have deep-rooted supply chains in China are likely to benefit. Take Apple, for example. Although the company had plans of shifting some of its production outside China in 2020, the world’s largest manufacturing site for iPhones in Zhengzhou has been busy recruiting new hires, signalling increased production activity.
Meanwhile, some American manufacturers are trying to bypass high labour costs by investing in automation, and investors could benefit from exposure to companies offering these solutions.
China generates more than $500 billion in annual domestic sales for over $700 billion in US assets. US investment has played a key role in fostering Chinese start-ups, accounting for nearly 16% of the $300 billion raised between 2000 and the first half of 2019. US FDI in China doubled (from 1.5% to 3.1%) between 1991 and 2001 and has remained at that level. While the quantum of US investment has been growing, China has been attracting other FDIs globally, reducing its reliance on US flows.
China has steadily become more important to the US, rather than the other way around. A nervous America responded to this by increasing its oversight of Chinese inflows. In 2019, a bill was passed threatening to delist US-listed stocks that fails to comply with the country’s auditing requirements. Investor concerns so far have been muted, with many firms like Alibaba already registering secondary listings elsewhere. And, with the Asian nation spearheading the post-pandemic global economic recovery, investor sentiment for China remains overly positive, as can be seen on the Acuity Trading Dashboard.
While the Biden administration hasn’t indicated plans to roll back tariffs, its focus seems to be on America achieving technology independence. The tech sector has led investment in China since the turn of the millennium. The US computer and electronic industry, for example, invested 9.8% of its total overseas investment in 2019 in China.
A China-US tech war has been raging in parallel to the trade war. Chinese telecom equipment manufacturer Huwaei and chip manufacturer SMIC were added to the US Department of Commerce's "Entity List" in 2019. The list prohibits the trade of US-backed technology to listed companies without a specific license. It is meant to protect US infrastructure from foreign influence and protect American innovation used in Chinese development. The tech industry has long accused China of piggybacking on American innovation with no intellectual property safeguarding.
The Biden administration intends to supplement these policies by strategically boosting US research infrastructure in critical technologies, earmarking $180 billion under its American Jobs Plan. It’s a good idea for investors to keep an eye on tech stocks, both for the pandemic-led fillip and Biden’s proposed investment. This is reflected in the mixed market sentiment for US tech stocks on the Acuity Trading Dashboard.
The semiconductor industry remains a cause of concern, as it faces an extended supply crisis without much hope of a solution in the near term. In time, this sector is poised to recover, given continued investment by both China and the US. America already dominates semiconductor design and has plans to internalise other aspects of the supply chain in alliance with Japan and South Korea.
Investors need to gauge the impact of the trade and tech wars on their portfolio. So far, the trade war has been a losing proposition for the US, and China has fallen far short of its 2020 purchase targets under their January 2020 trade deal. On the other hand, China has lowered agricultural trade barriers and improved IP protection. The tech war has so far been protectionist of American tech, increasing downside for companies that meet Chinese tech demand. However, the proposed investment will be expansive for the US tech industry and help stabilise global supply. Investors should also keep in touch with the increased scrutiny on inflows and outflows between the two superpowers, keeping in mind China's stated goal of reducing its reliance on the US dollar.