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Macroeconomic & Geopolitical

Investor’s Guide to the Second-Most Important Economic Challenge

13 November 2020 - 3 min read

After the pandemic recovery, the U.S.-China relationship will move into ever-more complicated and uncharted territory.

With America’s elections (mostly) over and vaccine news boosting recovery hopes, investors will soon return their focus to the world’s next-most important economic challenge: the increasingly fraught relationship between the United States and China. The next few months offer further risks around new pandemic outbreaks, fresh lockdown restrictions and a slow roll-out of medical breakthroughs, but soon enough markets will be firmly focused on the next chapter of Washington vs. Beijing. 

Markets may not miss Donald Trump’s unpredictable tweets, but the next headlines around TikTok or tariffs will reflect deeper trends that set the bilateral relationship on a much more complex and unpredictable course. Outright war is far from inevitable, but the drama will shape the world’s supply chains, technological innovation and financial flows. And the drama will play out on at least five interconnected levels.
 

  1. The Leaders: Media accounts, and therefore market sentiment, often focus on the personal chemistry between the leaders: Nixon and Mao, Reagan and Deng, Trump and Xi. President-elect Joe Biden can charm just about anyone he wants to, and he likes to tell the stories about how he has spent more time with Xi than any other American leader when they were both vice presidents and road buddies during extended visits to each other’s countries. If global differences could be patched up over dinner and a movie, then we’d be all set.
  2. The Bureaucracies: Alas, no matter how much two presidents get along, each country engages more concretely through its cabinet ministers, ambassadors and broader bureaucracies, which immediately introduce complications. Biden has yet to make his key international and economic appointments, but his new team will be greeted first by Chinese counterparts who likely feel battered and bewildered by four tumultuous years of negotiating with the Trump administration. Trump’s tariffs spurred China into talks, but both sides sent confusing signals the other interpreted as bad faith, according to a riveting account by two Wall Street Journal reporters. Meanwhile, China has fallen well behind in its promises to make large agricultural and manufacturing purchases under the deal.
  3. The Economics: The officials will start talking again, of course, and they may even find a way through their mutual suspicions in time. Much harder, however, will be landing on a next agreement that each side can take home to a domestic political audience that has grown much more suspicious of the other. While America was losing industrial jobs long before China’s admission to the World Trade Organization in 2001, the narrative of China abusing its access to international markets has taken root across the U.S. political spectrum, including among large firms that have grown frustrated with Chinese business practices. But the trade imbalances are rooted in far more than one-sided protectionism. “Trade Wars Are Class Wars” is how Michael Pettis and Matthew C. Klein explain the structural economic friction. China’s leaders, they argue, imposed a system that suppressed domestic wages and consumption, creating a dependence on foreign (and especially American) demand for their products. Meanwhile, trade surpluses in China (and Europe) have undercut American manufacturing and aggravated inequality and populist sentiment. Untangling these forces is not the work of a single administration.
  4. The Geopolitics: If these economic forces don’t look complicated enough, they are intensified still further by the great historical drama of a rising power challenging a dominant one. Harvard’s Graham Allison makes this case as he reviews similar moments back to the struggle between entrenched Sparta and upstart Athens. The dynamic does not lead to inevitable war, he points out, but it can. Careful management on both sides is crucial, which means framing negotiations around market access or intellectual property protection as problems in and of themselves, rather than skirmishes in a greater race for global dominance. 
  5. The Ideologies: The Chinese Communist Party is not out to re-litigate the Cold War that the Soviet Union lost on behalf of Marxism-Leninism. “The CCP actually functions as the Chinese Civilization Party,” in the words of Singaporean diplomat and scholar Kishore Mahbubani. It aims to return China’s greatness to “the oldest civilization on the planet.” Meanwhile, America, he argues, “operates from the assumption of virtue,” which often blinds it to the China’s legitimate grievances.

“President-elect Joe Biden can charm just about anyone he wants to, and he likes to tell the stories about how he has spent more time with Xi than any other American leader when they were both vice presidents and road buddies during extended visits to each other’s countries. If global differences could be patched up over dinner and a movie, then we’d be all set.”

This leaves investors to contemplate the coming headlines across all of these levels. The new Biden administration will likely be more methodical, with the next president eager to re-establish his relationship with Xi. His team will also quickly engage their counterparts on trade and technology and climate policy, but the broader structural and political differences will re-emerge soon enough. The tone may be more predictable, but the rising risks of misunderstanding may make the next chapters far more difficult.

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