One of our analysts at Evolution Partners, Ed Kilcommons, discusses the potential US-China decoupling and its implications for businesses. Do have a look through (it's a quick read, we promise!).
The U.S. and China are by far the two largest economies in the world, accounting for roughly 40% of global GDP. However, fears are mounting that they are increasingly viewing the financial and technological spheres as a zero-sum-game. With Hong Kong caught in the centre of this crisis, and shockwaves rippling throughout the finance and technology worlds, it is time for all forward-thinking businesses to consider whether this is the start of a New Cold War and what the consequences may be.
A brief history
When future historians date the beginning of the Sino-American split, they may look back to 2010, when China surpassed Japan as the 2nd largest economy in the world. A decade of rising tensions has followed.
In 2011, Goldman Sachs’ chief economist, Jim O’Neill, forecast China to surpass the US by 2027, and then Secretary of State Hillary Clinton made the infamous “Pivot to Asia” speech.
In 2012, 70% of China’s major leadership bodies were replaced in the largest shift in decades. Xi Jinping became President, marking a new era in U.S.-Sino relations.
Fast forward to 2016, Trump was elected on a major theme of “America First”, claiming that China had been “ripping off” the U.S. on trade for years.
2017 presented a thawing of relations. In February, Trump affirmed the One China Policy. On a visit to Beijing in March, Secretary of State, Rex Tillerson, described the U.S.-China relationship as one “built on non-confrontation, no conflict, mutual respect, and always searching for win-win solutions”.
However, this was the calm before the storm. In 2018 the U.S. claimed that China had been stealing U.S. technology and IP, with Trump announcing sweeping tariffs on Chinese imports worth $50bn. China responded with its own tariffs and numerous tit-for-tat measures that have further strained the relationship.
In 2019, Huawei was banned from U.S. federal agencies, and the trade war intensified. In August that year the Trump administration labelled China a currency manipulator, and in November signed a bill supporting Hong Kong protesters.
2020 began optimistically, with the ‘Phase One’ trade deal being signed in January. However, tensions skyrocketed as the coronavirus pandemic spread. On 18 June, Trump tweeted that “a complete decoupling from China” was possible.
A complete decoupling?
Is this really happening?
In late June this year, Michael Witt warned in the HBR that “as de-globalization accelerates, two hostile economic blocs are emerging, one centered around China and the other around the United States”. Indeed, whilst direct investment by U.S. multinationals into China actually rose slightly in 2019, Chinese direct investment into the U.S. has collapsed from a peak of $46.5bn in 2016 to only $4.8bn in 2019.
Trump is driving new legislation which would force Chinese companies that fail to comply with new oversight standards to delist from US equity markets within 3 years. SMIC (China’s largest semiconductor manufacturer) delisted from the U.S. in 2019 to only trade on the SEHK. Last Thursday, it secured a secondary listing in Shanghai, raising over £6bn as shares soared 246% on the first day. Amongst other Chinese companies, Alibaba, NetEase & JD.com have secured secondary listings in Hong Kong, potentially signalling a readiness to drop their U.S. listings.
Coronavirus has only accelerated this process, providing a justification for expanded reshoring whilst an artificial downturn in production makes relocating less painful than it might normally be. A global threat, in the form of a pandemic, has accelerated division rather than provide a common purpose. This does not bode well for other global issues, such as the climate crisis.
Are predictions of a “complete decoupling” overblown?
Earlier this month, the PIIE pointed out that “for all the fireworks over tariffs and investment restrictions, China’s integration into global financial markets continues apace. Indeed, that integration appears on most metrics to have accelerated over the past year”.
Certainly, the last year has seen an unprecedented liberalisation of China’s $47tn financial services market. Historically, foreign firms’ access has been restricted to joint ventures and minority stakes, and thus they only hold 2% of Chinese banking assets and 6% of its insurance market today. However, many U.S. multinationals, such as PayPal, Goldman Sachs, Morgan Stanley, J.P. Morgan, and American Express have made significant expansions in China over the past year.
Furthermore, amidst all the sanctions and browbeating, the ‘Phase One’ trade deal continues to whir away in the background. On 14th July, China purchased 1.762 million tonnes of U.S. grain, having bought another 1.365 million tonnes only four days earlier. These were the 1st and 3rd largest Chinese purchases of U.S. grain in history.
Significant unknowns
Perhaps the most alarming aspect of a US-China decoupling for businesses is not its speed or extent, but its uncertainty.
Coronavirus is one obvious unknown. How long will global flows of people and capital remain locked down? How severe will the economic depression be? Will ‘travel bubbles’ and ‘air bridges’ accelerate the formation of hostile economic blocs? Will allocations of blame continue to raise tensions?
The U.S. election in November is a possible but uncertain turning point. Currently, Biden is well ahead in the polls, but only a fool would eschew lessons of 2016 and rule out a Trump re-election. The consequences of a Biden victory are unclear. Though historically a trade and foreign-policy moderate, Biden has endured by shifting with the times, and U.S. public and political opinion against China is as close as you’ll get to a consensus in today’s schismatic America.
The view of U.S companies is also unclear. Whilst a March 2020 survey by the American Chamber of Commerce in China found that over 80% of US companies are not considering relocating their manufacturing out of China, a July 2020 Qima poll of 200 companies with global supply chains found that 95% of US respondents planned to change to suppliers outside China.
Implications for business?
A zero-sum-game?
Arguably the political, economic, and technological spheres are increasingly being viewed as zero-sum by both China and the U.S. This is concerning for many companies and countries, as they could be forced to choose to do business with one side or the other. Indeed, the U.K.’s decision on 15 July to ban Huawei from its 5G network speaks to this emerging binary. Clearly this developing division has drastic implications. Though it is not a set course, it is certainly one worth preparing for.
Banking sector
Trump is expected to sign the Hong Kong Autonomy Act into law. This would allow sweeping sanctions to be imposed on officials accused of undermining Hong Kong’s semi-autonomous status, along with the banks that do “significant transactions” with them. Combined with Hong Kong’s new national security law, which makes it illegal to comply with U.S. sanctions against Hong Kong and China, this could mean that financial institutions are forced to choose to only do business with one side.
Indeed, U.S. and European banks in Hong Kong are scrambling to conduct emergency audits of their exposure to this financial no man’s land. HSBC and Standard Charter significantly depend on Hong Kong for profits and have both been quick to support the new national security law.
Technology sector
Perhaps even more than multinational banking, technology sits at the forefront of this decoupling. Whilst the U.S. considers banning Chinese app TikTok (with 70 million active monthly American users), major U.S. tech companies are re-evaluating their future in Hong Kong. Facebook, Google, Twitter and Microsoft are “pausing” their co-operation with requests for user information from the Hong Kong authorities as they assess their position.
Apple is less immediately embroiled by the new legislation. However, it still faces a difficult dilemma – they made $44bn revenue in Greater China last year, more than any other U.S. tech firm, and much of their manufacturing is located there.
Huawei is perhaps the best example of the technological decoupling, with the U.S, U.K., Japan and Australia having banned the Chinese company from their 5G networks already. Moreover, following new U.S. restrictions on chipmaking tools, it is predicted that Huawei could run out of certain specialist chips by early next year. With its newly raised capital, SMIC could develop capability to produce all the chips China needs, but this would take several years.
Middle men?
As a new boutique firm, Evolution Partners will be far better placed to navigate this delicate environment. Having rapidly built out an international presence, Evolution Partners’ model allows it to remain embedded in each local market. Being agile and innovative, Evolution Partners is well placed to operate globally, whilst other firms are forced to withdraw to one sphere.
Sources
Bloomberg, ‘Next China’, 17 July 2020, https://www.bloomberg.com/news/newsletters/2020-07-17/next-china-tit-for-tat?srnd=premium
Council on Foreign Relations, ‘U.S. Relations with China 1949-2020’, https://www.cfr.org/timeline/us-relations-china
Cover image: Wikimedia, https://commons.wikimedia.org/wiki/File:FlagUSA_FlagPRC_crash.svg
Economist, ‘The tech cold war is hotting up: TikTok and the Sino-American tech split’, 11 July 2020,
https://www.economist.com/leaders/2020/07/11/tiktok-and-the-sino-american-tech-split
Foreign Policy, ‘The Great Decoupling’, K. Johnson and R. Gramer, 14 May 2020,
https://foreignpolicy.com/2020/05/14/china-us-pandemic-economy-tensions-trump-coronavirus-covid-new-cold-war-economics-the-great-decoupling/
FT, Banks in Hong Kong audit clients for exposure to US sanctions, P. Riordan and L. Lewis, 9 July 2020, https://www.ft.com/content/7b2b593e-5029-48b5-9c27-ff7f5473d66e
FT, ‘Tech giants at forefront of east-west decoupling’, 8 July 2020,
https://www.ft.com/content/0df00674-c058-11ea-9b66-39ae33ea12cb
HBR, ‘Prepare for the U.S. and China to Decouple’, Michael A. Witt, 26 June 2020,
https://hbr.org/2020/06/prepare-for-the-u-s-and-china-to-decouple
Peterson Institute for International Economics, ‘Despite the rhetoric, US-China financial decoupling is not happening’, N. R. Lardy and T. Huang, 2 July 2020, https://www.piie.com/blogs/china-economic-watch/despite-rhetoric-us-china-financial-decoupling-not-happening
South China Morning Post, Coronavirus, US-China trade war see 95 per cent of American firms wanting to ditch Chinese suppliers, F. Bermingham, 10 July 2020,
https://www.scmp.com/economy/china-economy/article/3092640/coronavirus-us-china-trade-war-see-95-cent-american-firms
Washington Post, ‘The coronavirus crisis is turning Americans in both parties against China’, Josh Rogin, 8 April 2020, https://www.washingtonpost.com/opinions/2020/04/08/coronavirus-crisis-is-turning-americans-both-parties-against-china/
