Cumberland Advisors Market Commentary – US vs. China – Competition vs. Conflict

Author: William Witherell, Ph.D., Post Date: January 25, 2021
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China’s economy grew at a 6.5% year-over-year rate in the fourth quarter, bringing growth for the full year 2020 to 2.3%. China’s was the only major economy to expand last year, despite the outbreak of the pandemic and the related economic shutdowns early in the year in China. That positive growth compares with a 3.5% decline of the US economy as the nation continues to battle an ongoing surge of COVID-19 cases.

Market Commentary - Cumberland Advisors - US vs. China – Competition vs. Conflict

 

The rapid recovery of the Chinese economy is providing welcome support for the global economy, a bridge until the expected recovery of the US and other advanced economies later this year. The Chinese economy is the globe’s second largest after the US economy and may become the largest as soon as 2028, according to the UK-based Centre for Economics and Business Research (CEBR). It accounts for 18% of the world’s GDP. However, China’s GDP per capita in 2020 was still less than $9,000, compared with more than $53,000 in the US, more than $47,000 in Japan, and about $36,000 in the European Union. The reason for this difference is that while China has a large and growing middle class that is well educated and a major force behind China’s economic growth, it also continues to have a huge number of poorer, less well educated citizens.

Competition between China and the advanced economies of the US, Japan, and Europe will continue for the foreseeable future. In this note we discuss the areas where that competition will likely continue – trade, technology, finance, geopolitical influence – and the risk that China’s relationship with the US and its allies will deteriorate from competition into conflict and/or isolation. The change in administrations in Washington reduces but does not eliminate the risk of a negative outcome for these relationships.

The Biden campaign stressed the need for a return to international cooperation, restoring relations with allies and with multilateral institutions and agreements. We expect that the US will continue to strongly oppose China’s restrictive, anticompetitive trade, industrial, and technology practices; but the Biden administration’s approach will differ from the unilateral protectionism pursued by Trump, as advised by Navarro and Lighthizer. They did not understand that China is the world’s biggest trading nation and is the largest trading partner of 64 countries. As the Financial Times points out, “Seeking to isolate China or sever its commercial links with the west is hence a non-starter.” The experience under Trump’s policies demonstrated that the costs of his tariffs was borne not by Chinese exporters but by US consumers and businesses. That unilateral approach resulted in Trump’s abandoning the Trans-Pacific Partnership and thus not being able to influence the important Asia-Pacific region multilateral trade agreement, in which China now plays a leading role.

The US, which is now having to play catch-up, will likely seek to work together with other countries to press for improved trade relations with China and to strengthen, not abandon, the World Trade Organization. What is needed is the development of agreed principles and procedures on how trade is to be handled among countries, including ones with different political and economic systems. As the Financial Times pointed out, “Multilateral institutions offer a framework within which disputes can be managed and new and better rules developed.” It will be important for the US to maintain and build upon the recent improvements that were achieved in China’s IP protections, rules against forced transfer of technology, and the opening up of financial services to US firms. We can also expect the US to take strong positions on human rights and environmental issues, but the harsh rhetoric of the Trump administration is expected to be dialed down.

Katherine Tai, Biden’s commendable choice for US Trade Representative, is unlikely to engage in threats of further unilateral tariff increases that would end up raising costs to US consumers and firms. She is also unlikely to reduce or eliminate the Trump tariffs without China’s also making concessions. Biden’s Secretary of the Treasury Janet Yellen testified that Biden’s priority at this time is upgrade the US economy through investments in American workers and infrastructure before liberalizing trade barriers.

International competition in the fields of science and technology is unavoidable and desirable. However, national security and intellectual property concerns must be considered. Certain critical technologies need to be protected and espionage countered. But national security limitations on trade and investment should be narrowly drawn, not used as an excuse or a cover for restrictions motivated by protectionism. Two issues will merit close attention by the Biden Administration: the Trump administration’s escalating measures to constrain US investment in Chinese companies with links to the People’s Liberation Army and the Commerce Department’s “blacklist” that prevents American companies from selling to listed Chinese companies without US government approval. Here, too, closer cooperation with our allies would be desirable, to identify what measures are needed and justified and then to take common action.

One scientific area where close cooperation between China and the US would be highly desirable is research on detecting and combatting serious diseases. COVID-19 will not be the last pandemic to threaten humanity. Biden’s urgent action to rejoin the World Health Organization is an important step in the right direction. A coordinated global effort to identify and contain outbreaks in any country at an early stage is in the interest of all.

China is becoming an increasingly important player in international financial and capital markets through its Mainland markets in Shanghai and Shenzhen and through Hong Kong. The Chinese government is encouraging this development. In our October 19 commentary entitled “China and Wall Street – Decoupling or Linking?” we noted that while the Trump administration was seeking to decouple relationships with China and to get global financial firms to pull back from that country, China, as an element in its sweeping financial liberalization program, was opening up its financial sector to increased foreign ownership and activities. US firms have been responding positively. China’s top financial official, Liu He, is seeking to increase financial discipline, indicating that a string of defaults in China’s bond market should be seen as salutary lessons. He said there is “zero tolerance” for misconduct or attempts to evade debts. China’s bond market is important. Its domestic bond market is the world’s second largest, and its offshore market, while still relatively small, has huge potential. Foreign investors now own some 10% of China’s sovereign bonds, presumably attracted by bond yields of over 3%.

Similarly, the central bank is bringing the financial activities of the Ant Group, the technology services giant, more closely under Beijing’s regulatory control, most likely by having the Ant Group form a financial holding company. There are good reasons for the Chinese regulators to be concerned about rising household debt and to pursue tighter regulation of the growing fintech sector. Bank regulators around the globe have similar concerns about regulating the fintech sector. At the same time the State Administration for Market Regulation (SAMR) is investigating Alibaba, the Ant Group’s sister company, for monopolistic practices. Regulatory actions to strengthen a financial market are commendable; but in China there is also a political dimension, an apparent desire to rein in the empire of Jack Ma, Ant Group’s founder and China’s most prominent proponent of private enterprise.

The Biden administration is not likely to seek decoupling of US and Chinese financial markets. The respective financial sectors will compete for business together with other regional and global markets. China’s importance in the financial and capital markets will continue to increase. The Chinese currency, the renminbi, is at a 30-month high, bolstered by China’s strong economic recovery from the COVID-19 pandemic. Its role in international commerce and finance will increase, but there is little chance the renminbi will approach the importance of the US dollar as a reserve currency in the foreseeable future.

There will continue to be some issues relating to US investments in the stocks of Chinese companies. The US under Biden is likely to continue to uphold the requirement that foreign firms listed in the US meet the accounting standards that all other listed firms are required to meet. A compromise that will permit Chinese firms to meet these standards is under consideration. This would involve allowing a “co-audit” in which US-listed Chinese companies’ US auditors would validate their Mainland subsidiaries’ work. The measures taken so far affecting US investments in Chinese companies with respect to national-security and human-rights concerns will be reviewed by the new administration.

At the geopolitical level, while the temperature and rhetoric are expected to be toned down, the Biden administration will maintain a firm line on matters such as China’s incursions in the South China Sea and will continue to have Taiwan’s back. It has already warned China to stop intimidating Taiwan by significant incursions into the Taiwanese air defense zone. Biden will likely be more outspoken than Trump was on human rights issues such as the treatment of the Muslim population in Xinjiang, the crackdown in Hong Kong, and the repression of dissidents. Should the US determine that sanctions are warranted, we expect it would seek to work together with US allies on the matter. There are areas where cooperation between the two major countries looks feasible, including global health, protection of the environment, economic development, and possibly counterterrorism.

With China and its neighbors in Asia (which have also been relatively successful in combatting the pandemic) looking likely to be the locomotive of growth in the global economy this year, Chinese and other Asian equity markets have been outperforming. Over the past 12 months months as of January 21, the iShares MSCI All Countries ETF, ACWI, advanced some 18.06% on a total return basis. Over the same period, the broad-based iShares MSCI China ETF, MCHI, which tracks an index that is composed of Chinese equities that are available to international investors, gained 42.49%. This outperformance continued over the past three months with MCHI gaining 17.67% compared with 15.72% for ACWI. Elsewhere in the region the iShares MSCI Hong Kong ETF, EWH, advanced by 21.62% over the past three months; the iShares MSCI Taiwan ETF, EWT, 27.56%; and the iShares MSCI South Korea ETF, EWY, 40.66%. Even stocks in the advanced, slow-growing Asian economy of Japan outperformed, with the iShares MSCI Japan ETF, EWJ, gaining 18.25%. We continue to be optimistic about the region and are continuing to overweight Asia in our International and Global Equity ETF portfolios.

Cumberland Advisors holds the MCHI, EWT, EWY, and EWJ ETFs in its portfolios. The author does not hold any of the ETFs mentioned in this commentary.

Bill Witherell, Ph.D.
Chief Global Economist & Portfolio Manager
Email | Bio

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Sources: Oxford Economics, Financial Times, chinalastnight.com, etf.com, The Economist, Center for Economic and Business Research


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