Biden Xi meeting could slow but won’t stop fraying economic and trade ties for U.S., China

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JIMBARAN, Indonesia – This week’s face-to-face meeting between President Biden and Chinese President Xi Jinping may represent a welcome easing of tensions, but it is unlikely to halt a slow erosion of financial and economic ties between the United States and China.

The past five years of acrimony between the United States and China over trade, technology and Taiwan have set in motion a realignment that is playing out in financial markets and corporate boardrooms around the world.

Investors in October pulled $8.8 billion out of Chinese stocks and bonds, continuing an exodus that began after the United States and Europe imposed sanctions on Russia over its invasion of Ukraine, according to the Institute of International Finance (IIF). At the same time, manufacturers trying to shore up vulnerable supply chains are turning to Vietnam or India instead of China.

“There is a big shift,” said Andrew Collier, an economist at GlobalSource Partners in Hong Kong.

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Business groups applauded Biden and Xi for stepping back from open confrontation and said planned follow-up meetings between top US and Chinese officials could herald further improvement. But, at least for now, the relationship between the world’s two largest economies seems stuck halfway between breaking up and rapprochement.

The three-hour meeting on the Indonesian resort island of Bali was different from Trump-era summits, which have been dominated by trade and tariffs. This time, the US readout of the talks mentioned Taiwan and human rights in Xinjiang, Tibet and Hong Kong before referring to “continued concerns about China’s non-trade economic practices, which harm workers and American families.”

For its part, the Chinese government rejected notions of an inevitable clash. Biden, who last month banned China from purchasing advanced American computer chips and related equipment, assured Xi that the United States does not intend to “decouple” from China or limit its economic development, according to China’s Ministry of Foreign Affairs.

“Starting a trade war or a technology war, building walls and barriers, and pushing to decouple and cut supply chains are contrary to the principles of the market economy and undermine the rules of international trade. These attempts do not serve the interests of nobody,” said the Chinese account of the meeting.

The session, however, did little to clear the clouds that have surrounded the financial ties between the giants. Numerous mutual funds this year, including public employee retirement plans in Florida and Texas, have reduced or eliminated their Chinese holdings.

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On Tuesday, S&P Global Ratings warned investors about the consequences if the United States imposed Ukraine-style sanctions on China. With the Chinese economy several times larger than Russia’s, the economic consequences would be enormous.

Blocking Chinese financial institutions from using the U.S. dollar, perhaps in response to a future attack on Taiwan, could leave them unable to make required interest payments on their bonds, S&P said. Of the 170 bond offerings by Chinese banks, investment firms and insurance companies over the past three years, none allow repayment in a currency other than the dollar, the rating agency said.

The mounting of national security alarms has already caused a shudder for what were once routine investments.

According to the Financial Times, BlackRock, which manages more than $10 trillion in assets, scrapped plans to market a new fund that would invest in Chinese government bonds, fearing it could clash with bipartisan anti- China in Washington.

It’s easy to see why the company has balked: This week, the House Financial Services Committee held a hearing on the potential national security risks associated with allowing US financing of “foreign rivals and adversaries.” .

If some investors fear the reaction from Washington, others are equally worried about the political developments in China. Tiger Global Management, a US investment firm, cut its holdings in Chinese stocks after Xi last month flouted recent rules and began a third term as China’s president, leaving some analysts convinced he plans rule indefinitely.

The company soured on Chinese investments due to rising geopolitical tensions and the economic fallout from Xi’s rigid zero-covid policy, according to a person familiar with the decision who spoke on condition of anonymity to discuss the company’s internal deliberations.

In the wake of the recent 20th Congress of the Communist Party of China, investors worry that market-oriented economic development is no longer the government’s priority. Instead, Xi is increasing the role of the state in the economy and consolidating one-man rule.

“The biggest open question is whether China is a safe environment for foreign investors,” Carl Weinberg, chief economist at High Frequency Economics, wrote in a client note on Tuesday.

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Starting in 2019, foreign investors flocked to China’s bond market to take advantage of higher yields than they could get in the United States. But in recent months, these flows have reversed.

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According to the IIF, foreign investors poured roughly $70 billion into Chinese bonds over a four-month period starting in March.

Both Russia’s invasion of Ukraine on February 24 and the Federal Reserve’s start of interest rate hikes in March caused investors to rethink their positions, said David Loevinger, CEO from TCW’s emerging markets group, a Los Angeles-based asset management firm.

“In the [Winter] Olimpic games [in Beijing], Xi gave Putin the big bear hug and two weeks later, the tanks rolled,” said Loevinger, a former U.S. Treasury Department official. “People were asking if China would be subject to sanctions. That was definitely a concern.”

Additional capital outflows would be a drag on Chinese financial markets. But the bigger issue is how companies are reshaping their supply chains.

For decades, the US and other manufacturers were drawn to China for its low-cost labor. But recurring production disruptions during the pandemic convinced them to establish multiple supply lines, despite the added cost.

Companies are looking for alternative locations outside of China for a variety of reasons. The overall relationship between the US and China has steadily deteriorated. Repeated covid lockdowns have made Chinese factories less reliable. And Washington’s bipartisan hostility toward China makes executives wary of betting too much on a country that is underdogs.

Among the companies ramping up production elsewhere is Apple, which will depend on India for a growing share of smartphone production.

The Biden administration is also promoting efforts to reduce the United States’ dependence on China for key minerals, pharmaceuticals and electric vehicle batteries.

US imports from China today are below their pre-trade war trend, according to a recent analysis by economist Chad Bown of the Peterson Institute for International Economics. The United States now buys products such as clothing and footwear from Vietnam that it previously bought from Chinese suppliers.

While trade data shows no wholesale decoupling, direct investment across the Pacific is evaporating. Chinese investments in building or acquiring American factories peaked in 2016 at nearly $49 billion, before sinking to less than $6 billion last year, according to the Rhodium Group, a consultancy based in New York. US direct investment in China has fallen from its 2008 peak of nearly $21 billion to about $8 billion in 2021.

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For now, the move away from China appears to be about redirecting future development rather than a broad retreat from an existing footprint.

A third of US companies in China said they had directed new investment to other countries in the past year, nearly double the percentage that did so in 2021, according to a recent survey by the American in Shanghai. Only 1 in 6 companies are considering relocating their existing operations in China.

“Xi Jinping’s clear signals about the contours of his administration’s economic policies, which will be less favorable to private enterprise, will likely discourage US investment in China and lead to continued gradual economic and financial decoupling “said former IMF official Eswar Prasad, who is now a professor of economics at Cornell University.

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Certainly, after four decades of increasing integration between the United States and China, there is little chance of a complete divorce. About $700 billion in goods will move between the two nations this year, up from last year’s level and more than six times more than in 2000, according to Census Bureau statistics.

China’s increasingly affluent consumers are central to the profit hopes of US companies such as General Motors and Microsoft.

Companies also cannot easily duplicate their Chinese production arrangements elsewhere. China’s ports, roads and rail networks are among the best in the world, complicating any plans to leave the country.

“Unless there’s real political pressure, I don’t see it,” said Michael Pettis, a professor of finance at the Guanghua School of Management at Tsinghua University in Beijing. “Once covid has passed, the only thing that matters is that if you move manufacturing out of China, you immediately become less competitive.”

Still, national security considerations are overshadowing pure economics in both nations. In Washington, the Biden administration is working on new regulations to limit investment in China. Xi wants China to produce more of the advanced technologies that are needed for military and commercial supremacy.

Expanding trade ties between the US and China under these conditions will not be easy.

“It’s difficult to manage competing interests,” said Eric Robertsen, global head of research and chief strategist at Standard Chartered Bank in Dubai. “But we have to find areas where we can cooperate. It is not in anyone’s interest that things go off the proverbial cliff.”

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