China and the US Endgame
by Jonathan Wu – Executive Director – Chief Investment Specialist
Premium China Funds Management
While we have seen on the one hand Avengers Endgame has beaten all records at the box office, so has the China US trade war broken records in terms of reversing almost 100 years of progress on globalisation. Many have chosen to focus on the short-term tit for tat strategies launched by the US in the name of “More open and free markets” yet all the actions taken by the Trump administration have only reflected an increase in protectionism.
What we need to focus on though as the title suggests is what the endgame looks like for this trade war that is threatening to derail global growth leading into 2020. Central banks have taken actions across the globe slashing rates trying to offset the effects of increased protectionism.
In order to work out this endgame we must first consider the demands made of the Trump presidency. While the trade war, and tariff implementations have made headlines, the three key demands remain unchanged since the start:
Equal Footing on Trade – If there is one thing that Trump has been consistent on in all his years in public life is that he believes the rest of the world has taken the US for a ride in terms of trade whether that be with China or India or any other country that it has significant ties with. The US simply wants China to import more US goods to balance out the trade deficit. On balance, this is something China is working on to effectively deescalate the overall tension. So, no major issues here.
Reduction in power of China’s central government influence on the economy – This second “demand” is ambitious no matter how you want to look at it. It’s not hard to conclude that neither the US, nor Trump has any right to dictate how China is to manage its economy. From an economic standpoint, if China didn’t have a command and control economy, they would not have been able to:
- Implement the $4tr RMB stimulus package back in 2008 to bring the world back from the brink of collapse due to the misgivings of the US capitalist society being the root cause of the global financial crisis.
- Bring a significant proportion of the population out of poverty in the speed in which they have done so.
- Even out population dispersion via its Hukou reform system to ensure tier 1 cities do not suffer from overcrowding.
- Build infrastructure like the high-speed rail network, the three gorges damn hydroelectricity generators to sure up electricity for the population.
While it is noted that the economy is command and control, at the heart of it is the core value of utilitarianism –achieving the greatest good for the greatest number of people. Without this core value, you would have not seen the wealth being generated within China over the last 3 decades.
Therefore, the US is very concerned. There are two parts to this. Firstly, on a macro economic front, China is getting closer to surpassing the US in terms of nominal GDP in USD dollar terms, but if you calculate GDP on a PPP (Purchasing Power Parity or the “McDonalds Index”) basis, China is already the largest, surpassing the US just a few years ago. By different estimates, on a nominal GDP basis in USD terms, China is looking to overtake the US by 2030. The US also understands this reality and is wresting with what it will mean for geopolitics in the future.
One technological advancement recently coined as the new “Cold War” is 5G. Huawei, one of China’s success stories in the private sector in telecommunications technology has successfully achieved 5G alongside other Chinese corporates and in places like Shanghai the speed has already hit 6000mbs in speed (to put this in context, our NBN locally maxes out at 100mbs.).
Why is 5G so critical? Because of the development of the next generation of tools including artificial intelligence and driverless cars. The 5G network spectrum would allow the transfer of information fast enough to make calculations so fast, that it could support these two technologies as well as increase the speed of commerce globally.
Former Google Chairman Eric Schmidt and LinkedIn founder Reid Hoffman published a report for the US government effectively stating that whoever leads 5G globally will stand to benefit from hundreds of billions of dollars in revenue across the next decade. They also made reference in the report that “That country is currently not likely to be the United States.”
So why then can’t the US achieve global 5G superiority like it has done with other technologies over the last few decades? It is a rather ironic reason to say the least. 5G needs low-band spectrum which allows signals to travel farther than high-band spectrum. What that effectively means is that if a signal can travel further, then less infrastructure has to be deployed saving overall CAPEX. Unfortunately, in the case of the US, that low-band spectrum is reserved for the military and hence cannot be used for commercial purposes.
Huawei, as a result of this problem the US faces, has been subject to sanctions including the arrest of its CFO Meng Wanzhou, as well as banning US firms in dealing with Huawei in the hope that it will slowdown Huawei and its 5G development and deployment.
The second concern on the part of the US is that many US conglomerates haven’t had the ability to successfully partake in China’s growth. This includes Facebook, Google, Apple and Uber. This is to a certain extent the direct result of China encouraging and supporting the growth of its local players in the same space three of which most people have now heard of – Alibaba, Tencent and Didi.
IP Law Enforcement and Opening Up of the Chinese Judicial System – This third “demand” of Trump is somewhat linked to the second demand as they want the Chinese government to step up in its efforts to protect intellectual property rights of more foreign firms. From the Chinese perspective, their priority is to protect the domestic players because they don’t want to be in a situation where there is still significant dependence on the US for key components (viz a vis Huawei).
While the Trump administration has continuously stated that the sanctions on Huawei has nothing to do with the trade war and is not being used as a pawn, all the evidence suggests otherwise vis a vis the agreement at the recent G20 meeting where Trump said he would raise the bans on Huawei if China started importing more agricultural goods from the US.
So given these demands, what is the endgame? The US will accept that it will no longer be the biggest economic power in the world. This is simply fact, and the best way to embrace this is not to reverse the positive effects of globalisation over the last hundred years through increased protectionism, but to work with China in a more culturally nuanced manner which respects the way the Chinese government runs its economy for the benefit of its people.
From an investment perspective, its also something we need to embrace when it comes to portfolio construction. Gone must be the days of saying China and Asia is a “niche” investment given China alone is the world’s second largest equities market. Embracing it means letting go of any biases or stereotypes you may had in the past and objectively understand the structure, culture and nuances of investing in the region and reaping the long-term fruits of that allocation.