In October, investors pulled $8.8 billion from Chinese stocks and bonds, continuing the exodus that began after the United States and Europe slapped 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 weak supply chains are turning to Vietnam or India rather than China.
“There is a huge shift happening,” said Andrew Collier, an economist with GlobalSource Partners in Hong Kong.
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Business groups have praised Biden and Xi for backing away from open confrontation and said planned follow-up meetings between senior US and Chinese officials could herald further improvement. But, for now at least, the relationship between the world’s two largest economies seems stuck halfway between rupture and convergence.
The three-hour meeting on the Indonesian resort island of Bali differed from the Trump-era summits, which were dominated by trade and tariffs. This time, the US reading of the talks referred to Taiwan and human rights in Xinjiang, Tibet, and Hong Kong before noting “lingering concerns about China’s non-market economic practices, which harm American workers and families.”
For its part, the Chinese government rejected notions that an inevitable clash would occur. Biden, who last month blocked China from acquiring advanced US computer chips and related equipment, has stressed that the US does not seek to “separate” 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 for the separation and separation of supply chains is contrary to the principles of the market economy and undermines the rules of international trade. The Chinese version of the meeting said such attempts serve no one’s interests.
But the hearing did little to clear the clouds over the financial ties between the giant companies. Several investment funds this year, including public employee retirement plans in Florida and Texas, have reduced or eliminated their Chinese holdings.
On Tuesday, ratings agency Standard & Poor’s warned investors of the consequences if the United States were to impose Ukraine-style sanctions on China. Since the Chinese economy is many times larger than the Russian economy, the economic repercussions will be enormous.
S&P said banning Chinese financial institutions from using the US dollar – possibly in response to a future attack on Taiwan – could leave them unable to make required interest payments on their bonds. The ratings agency said that of the 170 bond offerings made by Chinese banks, investment firms and insurance companies over the past three years, none allowed repayment in a currency other than the dollar.
The mounting national security alarms have already sent chills down on what were once routine investments.
BlackRock, which manages more than $10 trillion in assets, has scrapped plans to market a new fund that would invest in Chinese government bonds, fearing it would run counter to the bipartisan anti-China mood in Washington, according to the Financial Times.
It’s easy to see why the company refused: This week the House Financial Services Committee held a hearing on the potential national security risks associated with allowing the US to fund “foreign competitors and adversaries.”
If some investors fear Washington’s reaction, others are equally concerned about political developments in China. Tiger Global Management, a US investment firm, reduced its holdings of Chinese stocks after Xi last month broke with the latest benchmarks and began his third term as China’s president — leaving some analysts convinced he plans to rule indefinitely.
The company has soured on Chinese investments due to heightened geopolitical tensions and the economic fallout from Xi’s strict anti-virus policy, according to a person familiar with the decision who spoke on the condition of anonymity to discuss internal company deliberations.
In the aftermath of the recent 20th Congress of the Communist Party of China, investors are concerned that market-oriented economic development is no longer the government’s priority. Instead, Xi increases the role of the state in the economy and promotes one-man rule.
“The biggest question that remains open is whether China is a safe environment for foreign investors,” Carl Weinberg, chief economist at High Frequency Economics, wrote in a note to clients on Tuesday.
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Starting in 2019, foreign investors flocked to the Chinese bond market to take advantage of higher yields than they could earn in the United States. But in recent months, those flows have reversed.
Foreign investors dumped about $70 billion in Chinese bonds over a four-month period beginning in March, according to the Institute of International Finance.
The Russian invasion of Ukraine on February 24 and the start of interest rate hikes by the Federal Reserve in March caused investors to rethink their positions, said David Lovinger, managing director of the Emerging Markets Group of TCW, a Los Angeles-based asset management firm.
“In the [Winter] the Olympics [in Beijing]Lovinger, the former US Treasury official, said Xi gave Putin a big bear hug and two weeks later the tanks rolled. People were wondering if China would be subject to sanctions. Certainly, that was a concern.”
Additional capital outflows will be a drag on Chinese financial markets. But the biggest problem is how companies reorganize their supply chains.
For decades, the United States and other manufacturers have been attracted to China by low-cost labor. But frequent production outages during the pandemic have convinced them to set up multiple supply lines, despite the added cost.
Companies are looking for alternative locations outside of China for several reasons. Public relations between the United States and China have steadily deteriorated. Frequent coronavirus shutdowns have made Chinese factories less reliable. And Washington’s bipartisan hostility toward China makes executives wary of betting too hard on a country out of favour.
Among the companies boosting production elsewhere is Apple, which will count on India for a growing share of smartphone production.
The Biden administration is also promoting efforts to reduce US dependence on China for key minerals, pharmaceuticals and electric vehicle batteries.
US imports from China today are below trend before the trade war, according to a recent analysis by economist Chad Bown of the Peterson Institute for International Economics. The United States now buys products such as clothes and shoes from Vietnam that it once bought from Chinese suppliers.
While trade data shows a lack of wholesale decoupling, direct investment across the Pacific is evaporating. Chinese investment in building or buying US factories peaked in 2016 at about $49 billion, before falling below $6 billion last year, according to Rhodium Group, a New York-based advisory firm. US direct investment in China has fallen from its 2008 peak of roughly $21 billion to about $8 billion in 2021.
For now, the shift away from China appears to be more about reorienting future development rather than a broad rollback from the current footprint.
A third of American companies in China said they directed new investment to other countries last year, nearly double the percentage that did in 2021, according to a recent survey by Americans in Shanghai. Only 1 in 6 companies are considering moving their existing operations in China elsewhere.
“Xi Jinping’s clear signals about contours of his administration’s economic policies, which will be less favorable to private enterprises, are likely to discourage US investments in China and lead to continued gradual economic and financial decoupling,” said Eswar Prasad, a former IMF official. Now Professor of Economics at Cornell University.
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To be sure, after four decades of increasing integration between the United States and China, there is little prospect of a full divorce. Nearly $700 billion in goods will be moved between the two countries this year, up from last year’s level and more than six times higher than in 2000, according to a Census Bureau tally.
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Nor can companies easily replicate their Chinese production arrangements elsewhere. China’s ports, roads, and rail networks are among the best in the world, complicating any plans to abandon the country.
“Unless there is real political pressure, I don’t see it,” said Michael Pettis, a professor of finance at Tsinghua University’s Guanghua School of Management in Beijing. “Once Covid is behind us, all that really matters is if you move to manufacturing outside of China, you immediately become less competitive.”
However, considerations of national security overshadow the purely economics of both countries. In Washington, the Biden administration is working on new regulations to restrict foreign investment in China. Xi wants China to produce more advanced technologies needed for military and commercial supremacy.
Expanding trade relations between the United States and China under these circumstances will not be easy.
“It’s hard to manage competing interests,” said Eric Robertson, head of global research and chief strategist for Standard Chartered Bank in Dubai. But we have to find areas where we can cooperate. It is in no one’s interest to get things out of the proverbial abyss.”