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Macroeconomic & Geopolitical

The Dog That Hasn't Barked (Yet)

24 July 2020 - 3 min read

As the U.S.-China relationship unravels, it’s telling that both sides are still sticking with the modest “Phase One” Deal.

Editor's note: This week's Leading Thoughts was published by The Hill. 

When little makes sense in a troubled world, you can do worse than Sherlock Holmes and his reminder that things that don’t happen may be just as important as things that do. As the U.S.-China relationship plumbs new depths with each fresh exchange, the modest trade deal agreed upon in January may just be the dog that didn’t bark.

Even with rising accusations that China bears the blame for the global pandemic, even with a dramatic end to special treatment for Hong Kong, and even with a firm denunciation of China’s South China Sea claims as “illegal,” the January agreement still hangs by a thread. At least, as of this writing, both sides consider the obligations operative. The president says he’s not interested in “Phase Two” for now, but he has slapped down advisors who seem more eager to scuttle it. Chinese purchases of U.S. exports promised under the agreement are lagging badly through the Great Lockdown, but Beijing just placed a whopping order for American corn, signaling it hasn’t given up yet.

For investors, this means there are still important limits to the escalating tensions. So far, the moves against Hong Kong, the sanctions against Chinese officials and the increasingly florid name-calling have had less direct impact on the world’s largest economic relationship. At least for now, both sides seem to be shying away from moves that would further damage the global economy during its worst crisis in decades.
 

THE WORLD’S LARGEST ECONOMIC RELATIONSHIP (IN USD BILLIONS NSA)

Source: U.S. Census Bureau. As of  December 31, 2019.
 

Some of the heightened U.S. rhetoric might naturally be attributed to a U.S. president attempting to rally his base as current polls turn against him, but the relationship will surely remain troubled even after November 3, regardless of the result. Republicans and Democrats are remarkably united around getting tougher on China, and Joe Biden is unlikely to remove tariffs on Chinese goods just for goodwill.

Wang Yi, China’s foreign minister, recently bemoaned the course of events and called upon scholars and analysts to draw up three lists: areas where the two countries can cooperate, issues that can be resolved by negotiation and irreconcilable differences that need to be contained.  

He quoted this boss, President Xi Jinping, who reputedly has a soft spot for America dating back to his 1985 visit to Muscatine, Iowa with a Chinese delegation interested in farm technology. (It’s worth clicking here for the picture alone and a reference to his early fascination with Star Trek.) “There are a thousand reasons to make the U.S.-China relationship a success,” Xi told President Donald Trump when they first met at Mar-a-Lago in early 2017. “And not a single one to break it.” 

The message is striking from Wang, who has promoted so-called “wolf warrior” diplomacy to start pushing back aggressively against unfair criticism of China. It may best be viewed as a thinly veiled offer of a reset to a possible Biden Administration. Yet it offers a useful framework for investors trying to make sense of how the relationship may shape the global economy in the years ahead.  

The sharpest differences are the most emotional on both sides. The status of Taiwan and Hong Kong taps into deep historical wounds around Chinese humiliation and territorial division at the hands of foreign powers. U.S. concerns for minority rights and freedom of expression may not always be rigorously pursued, but they are deeply embedded in American values.

As for differences that should be managed, security and territorial issues may be the most prominent. Washington and Beijing share concerns over North Korea’s nuclear program but have differed over how best to make progress. China’s territorial claims have been stubborn and tone-deaf, but they hardly qualify as irreconcilable.

What is striking, however, is how many issues ought to fall into areas of cooperation and yet have become hostages in the relationship. Trade, by its very nature, should benefit both sides. Indeed, the size and scope of the economic relationship is what distinguishes this global rivalry from many of its predecessors. There was precious little commerce between the United States and the Soviet Union, let alone Athens and Sparta

But the economic elements of this relationship involve more than just the flow of goods and services across the Pacific or a big order for American farmers during an election campaign. There is an interdependence that extends well beyond digging out of the current recession. 

“The economic elements of this relationship involve more than just the flow of goods and services across the Pacific or a big order for American farmers during an election campaign. There is an interdependence that extends well beyond digging out of the current recession.”

China and the United States each want to shape the 21st century global economy through technological progress, standard-setting and financial flows. The problem is that neither side can really succeed without at least some cooperation from the other. In the near term, telecom giant Huawei still needs American semiconductors. In the long term, even as U.S. firms try to diversify away from China, they will always rely on Asian supply chains that cannot ignore Beijing.

None of this means that cooler heads will prevail, and Wang Yi’s three tracks will help steer more issues into the cooperative route. Over the next decade, the relationship will likely get worse before it gets better. But for an investor looking to size up the prospects for the three-quarters of a trillion dollar trading relationship, it’s worth noticing that amid the rising sound of snarling dogs, there is at least one who is still quiet.

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