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Will Biden reset the Sino-American relationship?

Summary:
As the clock ticks down on Trump’s days in the White House, and Biden election has been confirmed by the Electoral College, it’s time to ask if a Biden Administration will reset the Sino-American relationship. The key questions to ask are: What does each side want, and what are the sources of friction? What constraints is China operating under? What’s the likely path forward? While my main focus is on trade, that’s not the only dimension of friction between the two countries. China’s newly assertive foreign policy and brinksmanship in the South China Sea is also a source of concern for geopolitical stability. What does each side want? The first-order interpretation of the Sino-American trade relationship is Trump failed to make much of a dent in China’s trade surplus with

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As the clock ticks down on Trump’s days in the White House, and Biden election has been confirmed by the Electoral College, it’s time to ask if a Biden Administration will reset the Sino-American relationship. The key questions to ask are:

  • What does each side want, and what are the sources of friction?
  • What constraints is China operating under?
  • What’s the likely path forward?
While my main focus is on trade, that’s not the only dimension of friction between the two countries. China’s newly assertive foreign policy and brinksmanship in the South China Sea is also a source of concern for geopolitical stability.
Will Biden reset the Sino-American relationship?

What does each side want?

The first-order interpretation of the Sino-American trade relationship is Trump failed to make much of a dent in China’s trade surplus with America, which rose during his term. But that’s not the whole story.
 
Will Biden reset the Sino-American relationship?
Trump had a two-pronged negotiation strategy that was doomed to failure from the start. One complaint was China’s lack of respect for foreign intellectual property, which hampered American companies from operating in China, and the other was the trade deficit.
Here is the inherent contradiction. If the Chinese were to totally capitulate on the intellectual property issue and open its economy to foreign companies, the trade deficit would rise as American companies establish more plants in China and offshored jobs there. While President Trump was focused mainly on reducing the trade deficit, his negotiator Robert Lightizer operated with dual objectives, which were at odds with each other.
Be careful what you wish for.
It’s hard to escape the impression that the Sino-American relationship is damaged beyond repair. Tensions are rising on multiple fronts from trade to foreign policy. It’s useful to assess the current situation with a brief history lesson of how we got here.
Let’s go back to the 1990s with China’s ascension into the WTO. A Trumpian interpretation of events is American negotiators were suckered by the Chinese. A kinder version is Clinton’s negotiation team believed that bringing China into the light of WTO rules would force the regime to liberalize both its economic and political systems.
There was internal opposition from the Chinese side as well. China’s premier and principal negotiator Zhu Rongji was pilloried in certain quarters for giving away too much. His concessions were compared to the infamous and humiliating “21 points” which imperial Japan had tried to foist on China in 1915.
Before further discussion of what each side wants out of the relationship, we need to consider the constraints that China is operating under.

China’s unbalanced recovery

On the surface, China seems to be leading the world out of the Covid Crash. The latest figures show that its economic recovery strengthened in November. Industrial production rose, and so did retail sales.
Will Biden reset the Sino-American relationship?
Indeed, the China Exposure Index of US-listed companies with high exposure to the Chinese economy have rebounded strongly.
Will Biden reset the Sino-American relationship?
Patrick Zweifel at Pictet Asset Management observed that all of China’s main activity indicators are above pre-pandemic levels.
Will Biden reset the Sino-American relationship?
A closer examination of the above chart shows an unbalanced recovery. The rebound was led by fixed-asset investment and construction activity. Retail sales was the laggard. Beijing has returned to the same old formula of credit-fueled expansion. Moreover, Beijing has pivoted towards a state-owned led recovery. What happened to Deng Xiaopeng’s mantra of “it is glorious to be rich”?
China watcher Michael Pettis believes that the Chinese economy is reaching the limits of its growth model. Further credit-fueled growth, especially by the state-owned sector, will dampen productivity.

A GDP growth target that is below the underlying growth rate of the economy (as it was until 10-15 years ago, when GDP growth always exceeded the target) is consistent with a rising private-sector share of the Chinese economy. In that case private sector investment is profitable, and not surprisingly it drives much of the productive growth in the economy. But once the real growth rate of the economy slowed significantly, so that Beijing’s GDP growth target exceeded the country’s real underlying growth rate, the only way it could be met was with an increase in the state-sector share of the economy. In that case the private sector simply could not find enough productive activity to generate the politically-determined GDP growth target, and so the private-sector share of the economy necessarily had to decline.

Decoupling, by another name

Beijing’s latest solution is a “dual circulation” strategy, which amounts to maintaining global exports while developing a domestic supply chain. The Economist explains.

Enter the newest of China’s big economic policies: the “dual-circulation” strategy. At its most basic it refers to keeping China open to the world (the “great international circulation”), while reinforcing its own market (the “great domestic circulation”). If that sounds rather vague, it is: the government has not spelled out the details.

“Dual circulation” is just another term for decoupling.

That combination—the pursuit both of economic self-reliance and of greater economic leverage over foreign countries—now describes much of what China is doing. Mr Xi refers to changes “unseen in a hundred years” sweeping the global order—a way of saying that, while China is rising, America is declining and trying to stop the new power (see Chaguan). “Where linkages with the global economy create vulnerabilities, China wants to minimise them,” says Andrew Polk of Trivium China, a research firm. “Where the linkages create benefits, China wants to expand them.”

Decoupling is already a reality. Nikkei reported that a splinternet has developed, as cross-border data flow along the China/Hong Kong axis has skyrocketed while leaving the West behind.
 

Will Biden reset the Sino-American relationship?

China recently signed a free trade agreement which many interpreted as a counter-weight to the Trans-Pacific Partnership (TPP). The new agreement is called Regional Comprehensive Economic Partnership (RCEP), and it spans 15 countries and 2.2 billion people, or nearly 30% of the world’s population. Before everyone gets too excited, Michael Pettis poured cold water on the idea that RCEP will form a new parallel trade bloc.

The RCEP countries together have been running current account surpluses of more than 2% of their collective GDP, and except perhaps in the cases of Australia and New Zealand, these surpluses are based on structural savings imbalances. They are consequently very hard to eliminate without politically-difficult domestic adjustments that none of them want to accept.
 

This means that the RCEP can only function as a trade bloc either if some of its members are forced into running deficits (in practice only Australia and New Zealand, but they are too small to absorb more than a small fraction of the total), or if the RCEP is simply a surplus trading bloc in search of counterparts willing to run large deficits…
 

That leaves only the US, the UK, and Canada, and if they should take real steps to limit the deficits they are willing or able to run with RCEP, for example by limiting net capital inflows, the RCEP will fall apart as each surplus country tries to protect its all-important exports at the expense of imports and its trade partners.

China bulls believe that the strategy will ultimately compel China to open up its economy, according to The Economist.

Take the semiconductor industry. Caixin, a Chinese financial magazine, reported last month that Huawei, a tech giant, was rushing to create a “not-made-in-America” supply chain by 2022. Initially, however, that would enable it to make chips with transistors spaced 28 nanometres (billionths of a metre) apart, far less dense than the most advanced ones. The bullish case is that China, realising how long it will take to catch up in such areas, will try to boost productivity by cracking on with hitherto slow-moving reforms. Analysts with Huatai Securities, a brokerage, think that could include doing more to loosen the household-registration system known as hukou, which impedes the movement of rural labour to the country’s biggest and most productive cities.

Should China open its economy to foreign companies, the opportunities are still enormous. As an example, the WSJ reported that Wall Street is salivating over the prospect of entering China’s asset management industry, which is grown to about US $18 trillion. Foreign firms only have a minuscule market share at less than 2%.
 

Will Biden reset the Sino-American relationship?

What will Biden do?

In light of these challenges and opportunities, how will a Biden White House react to China?
 

President-Elect Biden has not outlined the specifics of his policy on China, but we can make some educated guesses. Jeff Bader was the point person for China policy during Obama’s first term. He outlined the issues in a Brookings Institute essay facing the Biden team as it takes office.

  • China’s growing power in all domains.
  • The halt, and in some cases reversal, of market driven reform of the economy and greater emphasis on central control and guidance at a time when Chinese economic power abroad is growing and, in many places, disruptive.
  • The return of stress on ideology, including indoctrination of officials in Marxism, tightening of space for dissent, heightened domestic surveillance enabled through technological advances, mass incarceration and “reeducation” of Uighurs in Xinjiang, and the recent crackdown in Hong Kong curtailing its autonomy and political freedoms.
  • Threats to neighbors through bullying and, in some cases, use of the PLA (People’s Liberation Army), notably the change in the status quo in the South China Sea and recent border clashes with India.
Bader believes that China’s threats may not as serious as initially perceived, especially on the geopolitical realm.

China will not be a global military power able to match the United States for the foreseeable future. America’s nuclear and ballistic missile forces, ability to project power, global system of alliances and bases, and war fighting experience are advantages that are unlikely to be eroded. China’s military poses a regional challenge but is not an instrument designed for an unprovoked attack on the United States. 

China’s economic power will rise, but it will not be globally dominant.

China’s economy will surpass the United States in gross domestic product, but it will lag well behind the United States in GDP (Gross domestic product) per capita for the foreseeable future. That will mean that demands for attention to domestic needs will continue to loom large for Chinese leaders. These domestic demands will provide some restraint on ambitious overseas spending (such as for BRI) that are unpopular in China. Internationally, there is no doubt that China’s spectacular surge to global leadership in trade, investment, and infrastructure development provides the country with greater influence, but China is many years, perhaps decades, away from being a rule maker rather than a rule taker in international finance, capital markets, and currency. It lacks the foundation of rule of law, currency and capital account convertibility, an independent central bank, and deeply liquid markets that international investors seek, all of which will be necessary for it to provide an alternative to the U.S. dollar as an international currency.

From an economic perspective, China is losing the war of ideas in globally. Macro Polo compared and contrasted the rise of Japan and the rise of China. While many countries rushed to emulate Japan’s business and economic development model at the time, none have done the same with China.

Much talk has centered on China’s influence in the West. But one important area where China barely registers influence is on Western industry’s practices and management thinking. In fact, when compared to Japan, China’s influence is notably weak in the corporate realm. 
 

The rise of “Japan Inc.” (~1950-1980) was accompanied by one of the most influential management concepts of the post-World War II era: the Toyota Production System, or commonly referred to as lean production. It wasn’t simply an idea, but an organizing principle with concrete practices that led to a transformation of the prevailing mass production model in the Western auto industry.  
 

In contrast, the rise of “China Inc.” (~1990-2020) has seen no equivalent management philosophy or practice that has come anywhere close to the influence that Japan’s lean production has exerted.  

Bader concluded that China is a competitor, but not an existential threat to American interests in the manner of the Soviet Union during the Cold War. Instead, it is seeking to be a dominant regional power and to carve out a sphere of influence in Asia.

There is no evidence suggesting that China seriously aspires to threaten the United States homeland or seek a global confrontation with the United States replicating the pattern of the U.S.-Soviet Union Cold War. Rather, we can expect to face a China that strives for economic preeminence in East and Central Asia, military security against the United States in the western Pacific, and rising but not predominant influence outside of Asia based largely on economic connections. We should not expect China to build up a network of like-minded or satellite states that pose a security threat to the United States, or to adopt the U.S. role in recent decades as the world’s policeman.
 

China is not an existential threat to the United States, but there is no avoiding the fact that we will be competitors and, in some respects, rivals — economically, politically, militarily, and technologically. That will require the United States to get its house in order in numerous ways that go beyond the scope of this paper, as domestic rejuvenation is the basis for successful competition. Such competition also will compel limitations on cooperation in some areas where the United States and China interacted relatively freely in the past. 

What does this mean for American policy? A consensus has developed in Washington that China represents a threat to US interests. The good old days of rapprochement are gone. The path of least resistance is a continuation of the multi-lateral containment approach last used by Obama. Biden is likely to re-enter TPP, which was a trade agreement designed to contain China’s growing influence. 
 

As well, Bloomberg reported an increased desire to challenge China from a geopolitical perspective.

Biden looks set to maintain or even expand the number of FONOPs [freedom of navigation operations in the South China Sea]. Jake Sullivan, his pick for national security adviser, last year lamented the U.S.’s inability to stop China from militarizing artificial land features in the South China Sea, and called for the U.S. to focus more on freedom of navigation.
 

“We should be devoting more assets and resources to ensuring and reinforcing, and holding up alongside our partners, the freedom of navigation in the South China Sea,” Sullivan told ChinaTalk, a podcast hosted by Jordan Schneider, an adjunct fellow at the Washington-based Center for a New American Security. “That puts the shoe on the other foot. China then has to stop us, which they will not do.”
 

The U.S. has played a key role in maintaining security in Asian waters since World War II. Yet Beijing’s military buildup, combined with moves to fortify its hold on disputed territory in the South China Sea, has raised fears that it could look to deny the U.S. military access to waters off China’s coastline. In turn, the U.S. has increasingly sought to demonstrate the right to travel through what it considers international waters and airspace.

That said, Biden will likely employ a multi-lateral approach to containment.

Biden may also try to get allies to join. A U.K. warship reportedly carried out a sail-by near the Paracel Islands in 2018, and French naval ships have patrolled in the South China Sea. A senior U.S. official said in July that the U.S. “would always like to see more like-minded countries participate” in the FONOPs program to build international consensus and pressure Beijing, the Australian Broadcasting Corporation reported.

How Biden reacts to the following key questions will also be clues to his China policy.
 

How will the new trade negotiator respond to China’s import benchmarks under the Phase One deal negotiated under Trump? Trump’s idée fixe was the trade deficit as a drain on American economic strength and jobs. Will Biden continue to focus on the trade deficit, or will he pivot to greater access to Chinese markets by American companies and intellectual property right protection?

How will Biden manage its relations with Australia? The China-Australia relationship has deteriorated badly in the past year. The degree to which Washington supports a key member of the Five Eyes Alliance in its dispute with China will be an important signal of the assertiveness of Biden’s China policy. Australia’s complaints include disagreements over the treatment of Hong Kong legislators, Chinese expulsion of Australian journalists, and an emerging trade war. A Bloomberg article detailed the list of trade sanctions that China has placed on Australian exports, such as beef, barley, coal, lobster, wine and timber, as well as non-tariff barriers on copper ore and concentrate, sugar, cotton, and wheat. Chinese diplomats recently distributed a list of complaints to Australian media about Canberra’s policies. 
“The document says Australia has unfairly blocked Chinese investment, spread ‘disinformation’ about China’s efforts to contain coronavirus, falsely accused Beijing of cyber-attacks, and engaged in “incessant wanton interference” in Hong Kong, Taiwan and Xinjiang.
It also lambasts the Federal Government’s decision to ban Huawei from 5G networks and criticises Australia’s push against foreign interference, accusing it of ‘recklessly’ seizing the property of Chinese journalists and allowing federal MPs to issue ‘outrageous condemnation of the governing party of China’.”

Investment implications

In the short-term, none of these concerns matters to the markets. The Chinese economy is enjoying a Recovery Renaissance. The yuan is strengthening against the USD.
 

Will Biden reset the Sino-American relationship?

The Chinese bond market is one of the few bond markets in the world that’s offering positive real yields. This will undoubtedly attract foreign fund flows, notwithstanding the heightened credit risk as evidenced by rising defaults. The relative performance of Chinese equities to MSCI All-Country World Index (ACWI), as well as most of the markets of China’s major Asian trading partners, are all showing different constructive patterns of positive relative strength.
 

Will Biden reset the Sino-American relationship?

In addition, the market is shrugging off the Australia-China trade and foreign policy friction narrative. The AUDCAD exchange rate just rallied to a fresh recovery high. Both Australia and Canada are resource exporting countries. Australian exports are more levered to China, while Canadian exports are more sensitive to the US economy. Strength in the AUDCAD exchange rate is a market signal of Chinese economic strength, and falling concerns over the Australia-China relationship.
 

Will Biden reset the Sino-American relationship?

China’s yuan strength and credit-driven recovery are also good news for Europe. European manufacturing is closely linked to the health of the Chinese economy, because China depend on Europe, and Germany in particular, as a source of capital goods. This is bullish for the euro, and bearish for the greenback. As well, a falling USD should provide a boost for commodity prices and emerging markets.
 

Will Biden reset the Sino-American relationship?

From a long-term perspective, however, CNY strength will create a headache for Chinese authorities. A strengthening currency will erode export competitiveness. While the PBoC can lean against yuan strength in the short-term, regulators are likely to encourage and accommodate greater capital outflows as a medium-term solution. However, the liberalization of the capital account will raise the risk of systemic instability. But that’s a problem for tomorrow.
 

In conclusion, Trump’s approach to the trade dispute with China was constrained by contradictory objectives. It was impossible to focus on both the trade balance and compel China to open up its markets and respect intellectual property. Should China open its markets, foreign manufacturers would flood in and offshore jobs there, and raise the trade deficit.
 

Biden is likely to pivot from a belligerent to a more multi-lateral approach to dealing with China. However, there is a growing consensus in Washington from both sides of the aisle that China is a strategic competitor. However, it does not represent an existential threat to the US in the manner of the Soviet Union during the Cold War. If the Sino-American relationship is due for a reset, it will be reset to the Obama-Bush-Clinton path of containment and engagement.
 

In the short run, China is leading the global economy out of a recession. Its strength is putting upward pressure on its currency and drawing capital inflows into its market. This momentum is expected to continue, and China and China related investments, such as commodities and Asian markets, should perform well.

About Cam Hui
Cam Hui
Cam Hui has been professionally involved in the financial markets since 1985 in a variety of roles, both as an equity portfolio manager and as a sell-side analyst. He graduated with a degree in Computer Science from the University of British Columbia in 1980 and obtained his CFA Charter in 1989. He is left & right brained modeler of quantitative investment systems. Blogs at Humble Student of the Markets.

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