Despite “Phase One,” U.S.-China Trade Dispute Likely to Linger
As “strategic competitors,” bilateral friction won’t go away anytime soon, but extensive economic integration and shared interests should facilitate longer-term accords and investment.
Markets have been celebrating the U.S. and China “Phase One” trade deal, with equities on both sides of the Pacific leaping higher. Economists are also penciling in slightly higher projections for Chinese economic growth, exports and sagging factory gate prices. But they might keep their erasers handy, and those driving up global stock prices on the basis of headlines should buckle their seat belts.
The median forecast of around six dozen economists in a recent Bloomberg survey puts China’s growth in 2020 at 5.9%, up a tad from 5.8% shortly before the trade accord was announced. While both China and the U.S. have much to gain from a de-escalation in the trade dispute, including attractive and abundant long-term investment opportunities, tensions are still likely to ebb and flow on a number of bilateral issues, depressing or boosting emerging market and developed world sentiment along the way.
The trade conflict, for example, appears to be morphing into a technological competition. Other issues include China’s maritime border claims, which don’t go over well with its regional neighbors or the U.S. Then there are the protests in Hong Kong and recently approved legislation that could result in sanctions against authorities in Hong Kong and Beijing if Washington concludes the island’s autonomy under the “one country, two systems” Sino-British Joint Declaration has been violated.
“I’m very concerned about what I see as a militarization of the U.S. view toward U.S.-China (relations),” former U.S. Treasury Secretary Hank Paulson said on Bloomberg’s David Rubenstein show last month. “National security has bled into basically every aspect of the economic relationship.” While pundits talk about a new “cold war” developing between the world’s two-largest economies, “there is no way this a Soviet-style cold war,” noted Paulson, who referred to China as a “strategic competitor” to the U.S. “China is very integrated into the global economy. China is the number one manufacturer; the number one trader; (and) a big exporter of capital.”
A Supplier of Last Resort?
Much is at stake in the bilateral relationship alone. The U.S. and China are each other’s largest single trading partners, with total bilateral trade running close to $700 billion at the end of 2018. Although Chinese investment restrictions have largely limited foreign portfolio flows into the Asian giant, the stock of U.S. foreign direct investment (FDI) in China amounted to $116.5 billion in December 2018, while Chinese FDI in the U.S. hit just more than $60 billion, U.S. Bureau of Economic Analysis data show.
Washington’s increasingly oppositional posture toward Beijing could cost U.S. businesses dearly, warned Chas Freeman, Jr., a former U.S. ambassador and senior fellow at Brown University. “By trying to reduce U.S. interdependence with China, the Trump administration has inadvertently made the United States the supplier of last resort to what is fast becoming the world’s largest consumer market,” Freeman warns. “One side effect of the new handicaps U.S. companies now face in the China market is more effective competition from Chinese companies, not just in China but in third-country markets, too.”
As Thornburg Portfolio Manager Matt Burdett pointed out, “China could provide material (natural) gas demand growth for years to come. But not necessarily for U.S. shale gas producers and LNG (liquefied natural gas) export terminals.” Burdett, who in late September met with LNG buyers in Beijing, Tokyo and Singapore, found that “for Chinese buyers, the trade war has left a lasting memory and will influence where they choose to source their long-term gas.”
That seems to be playing out. U.S. LNG exports to China fell to zero from May 2019 after three years of steady gains. The Energy Information Agency (EIA) also reports that U.S. coal exports to China dropped 64% over the first half of 2019 from the year-earlier period, even though the China’s coal consumption has been increasing since 2016 and the U.S. boasts some of the highest-quality coal in the world based on gross calorific value, or energy density, and lower ash and sulfur content. Meanwhile, U.S. average monthly exports to China of crude oil and refined products over the year through October 2019 were running at just less than half the year-earlier monthly average, according to the EIA.
“The Big Wave of History We’re Experiencing”
Beyond the impact on end-market demand, the trade dispute also spurs companies from various sectors to consider where to invest and how to organize their supply chains, says Thornburg Portfolio Manager and Chief Investment Strategist Brian McMahon. It also appears to have prompted Chinese authorities to support less efficient domestic producers in a bid to boost its labor market and sustain economic growth at close to 6%, he adds in a wide-ranging Q&A on the year ahead. As China’s contribution to global growth is the world’s single largest at close to 30%, Beijing’s push to keep the country’s economy chugging certainly helps worldwide growth. But the supply-side push may also be deflationary, if last year’s return of its producer price index into negative territory is indicative of a broader trend.
“The geopolitical risks are hard to factor into fundamental stock analysis,” McMahon says. “I’m just trying to pick good stocks and bonds.” Yet those risks and related headlines frequently swing risk asset prices, often affording bottom-up investors attractive levels at which to build, trim or exit positions.
As strategic competitors, U.S.-China tensions will no doubt flare and recede as political and economic relations adjust. But if the playing field levels through newly established intellectual property protections and effective enforcement mechanisms, a retraction of tariffs and steadier relations should set in. Given shared interests, from global stability to climate change, there’s reason for optimism. And for investors in both the U.S. and China, where a growing number of world-class companies are providing goods and services both domestically and abroad, the opportunities are enormous.
“Twenty years ago, there were 1.3 billion Chinese; some 900 million of them lived on farms and 400 million or so in cities. It hasn’t entirely flipped since then, but they’re making it happen. In my mind, that’s the big wave of history we’re experiencing,” McMahon says. “To accommodate that urbanization, the Chinese government had to create jobs and modernize the economy. And they’ve pretty much done that in just two decades. It’s absolutely amazing.”
 Economists Boost China Outlook on Trade Deal, Survey Shows, Bloomberg, 12/19/2019
 On Hostile Coexistence with China, Chas Freeman, Jr., May 2019