The US-China conflict challenges the world

Smaller countries should band together to sustain multilateral free trade

Martin Wolf

Where does deepening economic conflict between the US and China leave the rest of the world, especially historic allies of the US? In normal circumstances, the latter would stand beside it. The EU, after all, shares many of its concerns about Chinese behaviour. Yet these are not normal circumstances. Under Donald Trump, the US has become a rogue superpower, hostile, among many other things, to the fundamental norms of a trading system based on multilateral agreement and binding rules. Indeed, US allies, too, are a target of the wave of bilateral bullying.

So what are American allies to do as the US and China battle? This is not just about Mr Trump. His focus on bilateral trade balances may even be relatively manageable. Worse, a large proportion of Americans shares a deepening hostility not just to China’s behaviour, but to the fact of a rising China.

We are also seeing a big shift in conservative thinking. In 2005, Robert Zoellick, deputy secretary of state, argued that China should “become a responsible stakeholder” in the international system. Recently, Mike Pompeo, secretary of state, has indicated a different perspective. Foreign affairs specialist Walter Russell Mead describes Mr Pompeo’s animating idea as follows: “Where liberal internationalists believe the goal of American global engagement should be to promote the emergence of a world order in which international institutions increasingly supplant nation-states as the chief actors in global politics, conservative internationalists believe American engagement should be guided by a narrower focus on specific US interests.” In brief, the US no longer sees why it should be a “responsible stakeholder” in the international system. Its concept is, instead, that of 19th century power politics, in which the strong dictate to the weak.

This is relevant to trade, too. It is a canard that the trading system was based on the notion that international institutions should supplant nation states. The system was built on the twin ideas that states should make multilateral agreements with one another and that confidence in such agreements should be reinforced by a binding dispute settlement system. This would bring stability to the conditions of trade, on which international businesses rely.

All this is now at risk. The spread of the tariff war and the decision to limit the access to US technology of Huawei, China’s only world-leading advanced technology manufacturer, seem aimed at keeping China in permanent inferiority. That is certainly how the Chinese view it.

The trade war is also turning the US into a significantly protectionist country, with weighted-average tariffs possibly soon higher than India’s. A paper from the Peterson Institute for International Economics states, that “Trump is . . . threatening tariffs on China that are not far from the average level of duties the United States imposed with the Smoot-Hawley Tariff Act of 1930.” Tariffs may even stay this high, because the US’s negotiating demands are too humiliating for China to accept. These levies will also lead to diversion to other suppliers. Tariffs may then spread to the latter, too: bilateralism is often a contagious disease. Contrary to Mr Trump’s protestations, the costs are also being borne by Americans, especially consumers and farm exporters. Ironically, many of the worst hit counties are in Republican control. (See charts.)

Some might conclude that the high costs mean that the conflict cannot be sustained, particularly if stock markets are disrupted. An alternative and more plausible outcome is that Mr Trump and China’s Xi Jinping are “strongmen” leaders who cannot be seen to yield. The conflict will then either remain frozen or, more likely, worsen as relations between the two superpowers become increasingly poisoned.

Where does this leave US allies? They should not support American attempts to thwart China’s rise: that would be unconscionable. They should indicate where they agree with US objectives on trade and technology and, if possible, sustain a common position on these issues, notably between the EU and Japan. They should uphold the principles of a multilateral trading system, under the auspices of the World Trade Organization. If the US succeeds in rendering the dispute system inquorate, the other members could agree to abide by an informal mechanism instead.

Most significantly, it should be possible to sustain liberal trade, at the expense of the US and China. Anne Krueger, former first deputy managing director of the IMF, notes in a column that, by its own foolish decision to reject the Trans-Pacific Partnership, the US suffers from WTO legal discrimination against its exports to members of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, which replaced TPP. The EU also has free trade agreements with Canada and Japan.

This is good. But they can go further. Countries that see the benefits of a strong trading order should turn such FTAs into a “global FTA of the willing”, in which any country willing to accept the commitments could participate. One might even envisage a future in which participants in such a global FTA would defend its members against illegal trade assaults from non-members, via co-ordinated retaliation.

Hostility between the US and China is a threat to global peace and prosperity. Outsiders cannot halt this conflict. But they are not helpless. If the big powers stand outside the multilateral trading system, others can step in. They are, in aggregate, huge players. They should dare to act as such.

China battles the US in the artificial intelligence arms race

What counts is implementation not innovation, and here the Chinese have big advantages

Martin Wolf

In late March I attended the China Development Forum for the ninth time. The visit stimulated my recent observations on China’s economy and politics. But what makes the CDF most valuable is serendipity. This time that came in the shape of a meeting with Kai-Fu Lee, former president of Google China and now a leading venture capitalist in Chinese technology.

Mr Lee gave me a copy of his new book, AI Superpowers: China, Silicon Valley and the New World Order. This has a startling story to tell: for the first time since the industrial revolution, he argues, China will be at the forefront of a huge economic transformation — the revolution in artificial intelligence.

He starts his book by talking about China’s “Sputnik moment”, when Google DeepMind’s AlphaGo defeated Ke Jie, the world’s leading player of the ancient Chinese game of Go. This demonstrated the capacity of modern AI. But, by implication, Mr Lee’s book foresees another such moment, when the US realises it is no longer leader in the global application of AI. The original Sputnik moment occurred when the Soviet Union put the first satellite in orbit in 1957. This led to the space race of the 1960s, which the US duly won. What will the present “race” lead to?

Mr Lee does not claim that China will lead in fundamental innovation in this area. But that may not matter, since the big intellectual breakthroughs have already occurred. What matters most is implementation, not innovation. Here China has, he writes, many advantages.

First, the work of leading AI researchers is readily available online. The internet is, after all, a superlative engine for spreading intellectual breakthroughs, not least including those in AI.

Second, China’s hypercompetitive and entrepreneurial economy lives by Facebook founder Mark Zuckerberg’s notorious motto: “move fast and break things”. Mr Lee describes a world of cut-throat business activity and remorseless imitation, which has already allowed Chinese businesses to defeat leading western rivals in their home market. The ceaseless “trial and error” of the Chinese business model is, he argues, well suited to rolling out the fruits of AI across the economy. It could, for example, work far better in introducing autonomous vehicles than the west’s safety-conscious approach. China’s swarms may be inefficient, but they are effective. That is what matters.

Third, China’s dense urban settlements have created a huge demand for delivery and other services. “American start-ups like to stick to what they know: building clean digital platforms that facilitate information exchanges,” Mr Lee argues. But Chinese firms get their hands dirty in the real world. They integrate the online and offline worlds.

Fourth, China’s backwardness allowed businesses to leapfrog existing services. So China has been able to jump to universal digital payment systems, while western businesses still use outdated technology.

Fifth, China has scale. It has more internet users than the US and Europe combined. If data is indeed the fuel of the AI revolution, China simply has more of it than anybody else.Sixth, China has a supportive government. Mr Lee cites a speech by premier Li Keqiang in 2014 at the World Economic Forum’s “summer Davos”, calling for “mass entrepreneurship and mass innovation”. In his report “Deciphering China’s AI Dream”, Oxford university’s Jeffrey Ding points to the State Council’s national strategy for AI development. China’s government has ambitious goals and is willing to take risks to achieve them. One of the things China can do more easily than anywhere else is build complementary infrastructure.

Finally, writes Mr Lee, the Chinese public is far more relaxed about privacy than westerners.

Chinese leaders, it may be argued, see no justification for individual privacy at all (except for their own).
 So where is this supposed “race” between the US and China today? Mr Lee distinguishes four aspects of AI: “internet AI” — the AI that tracks what you do on the internet; “business AI” — the AI that allows businesses to exploit their data better; “perception AI” — the AI that sees the world around it; and “autonomous AI” — the AI that interacts with us in the real world. At present, he thinks China is equal to the US in the first, vastly behind in the second, a little ahead in the third, and, again, far behind in the fourth. But five years from now, he thinks, China might be a little ahead in the first, less far behind in the second, well ahead in the third and equal in the last. There are, to his mind, no other competitors.

Mr Ding analyses the drivers differently. He distinguishes hardware, data, research and the commercial ecosystem. China is far behind the US in production of semiconductors, ahead in the number of potential users and has about half the number of AI experts and roughly half the number of AI companies. All told, China’s potential is about half that of the US. Yet Mr Ding is looking at AI overall, while Mr Lee focuses on commercial applications.

Historical experience suggests that the rents created by a lead in an important technology are valuable, though often impermanent. So, which country will be ahead in the application of AI is indeed important. But the economic and social impact of AI is a bigger issue and one that is relevant to every country.

As Mr Lee stresses, advances in AI offer gains. This is not just in personal convenience, but in improving medical diagnostics, tailoring education to individual students, managing energy and transport systems, making courts fairer, and so on and so forth.

Yet AI also threatens huge upheavals, notably in labour markets. Many of the jobs (or tasks) that AI might do are today done by relatively educated people. It seems reasonable to fear that AI will accelerate the hollowing out of the middle of the earnings distribution, possibly even the upper middle, while increasing concentrations of private wealth and power at the top.

Yet perhaps the most important consequence will be in the intensity of influence and surveillance made possible by AI-monitored mobile devices and sensors. George Orwell’s Big Brother (or many big commercial brothers) might watch us all the time. Such perfect monitoring might be attractive to China’s state. It is horrible to me and, I hope, billions of others.

AI, Mr Lee insists, is not the same as artificial general intelligence: the true super brain is far away. Even so, the challenges this AI creates are huge. We will not stop it. But we may in the end conclude we have birthed a monster.

The Terrifying Truth About Negative Interest Rates

Pushing interest rates below zero is both an act of desperation and something that in theory should have a huge, immediate impact of the behavior of borrowers and savers. The fact that negative rates have become the new normal in big parts of the world but haven’t caused the expected behavior change should scare the hell out of everyone.

To understand why this is so, think of the rate of interest as the price of money. It’s what an individual or business has to pay to get credit with which to buy and invest. As with anything else, when the price of money is high, we tend to acquire less of it and when the price is low we acquire more. So making money not just cheap, not just free, but actually profitable to borrow, while making savings unprofitable to hold should, according to conventional Keynesian economics, create a scene in the credit markets reminiscent of those Black Friday Wal-Mart videos where fistfights break out over the last remaining Barbie Doll. Businesses in particular should be borrowing and investing like crazy, igniting an epic capital spending boom.

But that hasn’t happened. In Europe, for instance, negative rates have been in place for five years …

negative interest rates Europe

… and instead of a rip-roaring post-Great Recession recovery, the result has been the kind of anemic growth that conventional economics would predict for a tight-money environment.

Business capital spending, the engine that in theory should be propelling Europe’s economy, looks like the opposite of a boom.

Europe capital spending negative interest rates

This translates into seriously boring GDP growth:

Europe negative interest rates Europe

Why call such an uneventful situation terrifying? Because of what comes next.

Europe’s current sub-2% average growth rate is too slow to stop debt-to-GDP from rising. In other words, even with negative interest rates the Continent continues to dig itself ever-deeper into a financial hole. The same death spiral dynamic is in place in US, Japan and China.

To put the problem in more familiar terms, the world’s central banks have launched their version of tactical nukes at the problem of slow growth and soaring debt, and the dust has cleared to reveal the enemy unscathed and coming back for another go.

The next recession will begin with interest rates already at emergency levels, leaving central banks with no choice but to launch even bigger nukes. If interest rates are currently at -0.5%, then push them down to -5%. If buying up every investment-grade bond didn’t work last time around, then buy up junk bonds and equities, and maybe pay off everyone’s mortgage and student loans.

This will also fail, for reasons best explained by the unfortunately non-mainstream Austrian School of economics. The Austrians focus on a society’s balance sheet and observe that when low-quality (that is, speculative) debt exceeds certain levels, there’s nothing to be gained by encouraging more borrowing. So go ahead and cut interest rates to any crazy level you want.

The inevitable, necessary result of too much bad debt is a crash that wipes that debt out. Or a hyperinflation that destroys the currency with which desperate governments flood the market in an attempt to stave off the debt implosion.

This explains why today’s negative interest rates haven’t ignited a boom (there’s already too much bad paper circulating), and also why the next round of monetary experiments will fail even more spectacularly.

The US is seeking to constrain China’s rise

Ban on companies supplying Huawei is damaging and ill-conceived

The editorial board

However great the vulnerabilities in Huawei and the broader Chinese tech sector that they have revealed, the US steps may also ultimately fail © Reuters

Huawei is under siege. Google is restricting parts of its Android operating system to the Chinese telecoms tech giant. US chipmakers are poised to suspend supplies too. The US move to put the Chinese telecoms flagship on its so-called Entity List — requiring American companies to obtain a government licence to sell to it — is a pivotal moment for the global technology industry. It represents an opening salvo in an emerging new US-China cold war. It is also a serious miscalculation.

All countries have a right to protect national security interests — nowhere more than in 5G telecoms, nervous system of the future digital economy and the “internet of things”. The Trump administration’s moves last week, however, go far beyond what is needed to address security concerns. They also seem far more than an attempt to pressure Beijing into reaching a trade deal.

They amount to an effort to decouple the US and Chinese tech sectors, leading to a bifurcation of the global industry. This reflects a view reaching beyond the Trump White House and deep into the US security establishment that President Xi Jinping’s China is a malign actor, and that its technology is on course to outstrip America’s. Indeed, the US steps appear part of an attempt to constrain China’s rise.

Echoes of the Soviet era abound, but Soviet industry was never entwined with America’s in the way China’s is. The latest US moves seem designed to cripple or crush one of the first Chinese tech companies to become globally competitive — and one that relies on American suppliers in both mobile phones and network equipment.

Assuming the US administration sticks to its measures, despite heavy lobbying by US businesses, they will damage American and other western corporate interests. Allied capitals will resent the White House’s efforts to impose its writ.

However great the vulnerabilities in Huawei and the broader Chinese tech sector that they have revealed, the US steps may also ultimately fail. They are likely to spur a Beijing-led effort to address China’s weaknesses and develop a fully independent supply chain. A historical analogy might be China’s nuclear weapons programme: the departure of Soviet advisers in the late 1950s forced it to build its own A-bomb. The result could hasten a splintering of the internet and associated technologies to which China and Russia, which recently passed a law ensuring it can cut itself off the world wide web, have already contributed.

Indeed, while China is complaining bitterly about the US moves, Beijing must take a good share of the blame for the situation it is now in. China has blocked multiple foreign companies and websites, including Twitter, Facebook, and Google services including Gmail and YouTube. The number of European companies compelled to hand over technologies in exchange for market access in China has doubled in two years, a report showed on Monday. While western intelligence agencies disagree on the size of the security threat Huawei represents, all point to China as the biggest source of cyber attacks on security and industrial assets.

If China wishes to change its image as a malign force, it must rein in such attacks. Yet Washington’s coercive steps are misguided. The US and the west should not seek to block China’s rise but encourage it to co-operate in a rules-based system, by setting good examples themselves. Washington’s allies should be free to determine what steps they judge necessary to combat security threats from Huawei or others. The US has the right to take security steps too — but not to allow these to slide into destabilising protectionism.

Suddenly, There's Not A Lot To Like

by: The Heisenberg
- Over the past three weeks, the macro narrative has taken a decisive turn for the worst.

- The Huawei bombshell looks to have made negotiations between the US and China all but impossible in the near term and Beijing is circling the wagons.
- It wasn't clear that China's economy was out of the woods and the renewed trade tensions muddy the waters considerably.
- Meanwhile, things are going off the rails in Italy again ahead of the EU elections.
It took three business days from time the US effectively blacklisted Huawei for the Trump administration to offer a concession in the form of a temporary general license that permits some transactions with the company and its dozens of non-US affiliates.
Until August 19, Huawei is permitted to buy American goods necessary to ensure existing networks remain operational and to update software on existing Huawei devices.
The decision came on Monday evening, following what I described over on my site as a "mini-panic" across the global technology supply chain. Last week, in a post for this platform, I suggested the Huawei gamble was something of a "crossing the Rubicon" moment for markets. In that post, I flagged the SOX (SOXX), which, through Friday, was headed for its second-worst month since May of 2012. By the closing bell on Monday, semi stocks were on track for their worst month since the crisis.
You didn't have to be any kind of seer to know that some manner of intervention from the US Commerce Department was in the cards. Monday wasn't an especially bad day for global equities on the whole, but the rout in semis was disconcerting for what it telegraphed about how the market was interpreting the Huawei decision. Literally minutes before the temporary general license announcement was posted to Commerce's website, I said the following in a short little post called "When The Chips Are Down":
Presumably, the Commerce Department will be forced to adopt some kind of middle ground that ameliorates market concerns and helps cushion the blow. Otherwise, this is going to quickly erode confidence. Given that the weakness in the chip space is indicative of an actual, real-world bid to dismantle the global technology supply chain, it’s difficult to imagine how this doesn’t spill over and prompt an across-the-board rout at some point in the very near future unless the Trump administration comes forward with something definitive regarding how they plan to mitigate the fallout from last week’s decision.
If you looked out across the headlines on Tuesday evening, most financial media outlets attributed Wall Street's good day to the temporary, partial reprieve granted to Huawei. The SOX rallied more than 2% and the SPDR S&P Semiconductor ETF (XSD) bested the S&P ETF (SPY) after three consecutive days of grievous underperformance. The yellow, dashed lines in the following visual mark the day the Huawei ban was announced.
To be clear, a 90-day partial reprieve from Wilbur Ross isn't going to cut it when it comes to restoring confidence and convincing market participants that the US fully appreciates the gravity of this situation. You might think the rout in the chip space is over done, but the reality is that nobody knows where this is headed. "We would expect that many, if not most, semiconductor companies will need to lower estimates," Raymond James wrote Tuesday, in a note cited by Bloomberg for a piece aptly entitled "US Chipmakers Preparing for China Trade Fight Fear That All Will ‘Suffer’".
Beyond the ramifications for semis, investors should step back and try to appreciate the big picture. I've attempted to communicate why the Huawei story is so momentous in at least a half-dozen posts over the past four days in addition to the two linked above. This is China's crown jewel on the line. Huawei is Beijing's national champion. Although the rhetoric from Chinese state media was already pretty shrill following the Trump administration's move to more than double the tariff rate on $200 billion in Chinese goods, the tone became overtly hostile following the Huawei decision. In remarks cited by a widely-read piece in the South China Morning Post, Xi on Tuesday appeared to suggest that China is preparing for an indefinite war of attrition.
Also on Tuesday, Bloomberg said the Trump administration has "for months" held off on punishing Huawei for fear of undermining the trade talks. That might sound like an innocuous headline, but it's not. Since the arrest of Meng Wanzhou in December, US negotiators have been at pains to insist that trade talks are separate from national security concerns. Implicit in that insistence was a promise that Huawei and Meng wouldn't be used as leverage. The Bloomberg story (which cited unnamed sources) suggests the US always intended to play the Huawei ace in the event the terms of a prospective trade deal weren't deemed favorable enough for Washington.
Importantly, some of China's recent stimulus efforts have been inward-looking, seemingly designed to bolster domestic demand rather than rescue the global cycle. That could be due to worries that the monetary policy transmission channel is clogged by lackluster demand for credit, or it could just be that Beijing is taking a "China first" approach this time around when it comes to stimulus. Whatever it's attributable to, it's reasonable to assume that in an all-out trade war scenario, that tendency to focus inward will be redoubled. Consider this from Barclays:
China’s stimulus has failed to boost exports from trading partners like Korea and Taiwan implying that China’s stimulus is domestically oriented and that the improvement in fixed asset investment is driven by real estate/ infrastructure at the expense of manufacturing, thereby increasing the efficacy of the policy measures domestically and limiting the amount of pass-through of this stimulus to the rest of the world. We therefore see risks of a prolonged and soggier soft patch in the global economic recovery compared to 2016. 
When you throw in the fact that April activity and credit growth data missed estimates, you're left with somewhat vexing concerns about the outlook in an environment where the US is turning the screws as tight as they'll go.
With that in mind, remember that for the better part of a decade, China has been the engine of global growth and credit creation. That's a point that's been emphasized and reemphasized by analysts since 2015, when the yuan devaluation rattled markets and China concerns were top of mind.
"Following the Global Financial Crisis, Washington had too many problems to focus on China, plus the Chinese were the driving force behind global GDP and debt creation after 2008 in a world hungry for growth," Bank of America writes, in a note dated Monday, adding that "the European sovereign debt crises of 2011 and 2012 made Chinese economic activity an even more important pillar of the world economy."
The recovery from the crisis has been tepid, and although 2017 was characterized by synchronous global growth, "gangbusters" isn't a term you'll hear anyone use to describe the pace of economic expansion in developed economies. There will probably never be an "ideal" time to confront Beijing on trade, and it's true that fiscal stimulus in the US has given the Trump administration a growth cushion (so to speak) when it comes to pushing the envelope, but there is a certain sense in which undercutting China's economy amounts to cutting one's nose of to spite the face.
At the same time, the renewal of trade concerns is weighing heavily on emerging market equities which have now erased most of their gains for the year. Notably, recent underperformance has pushed the ratio of the iShares MSCI Emerging Markets ETF (EEM) to the S&P ETF below 2018's nadir (top pane).
Meanwhile, things are going off the rails in Italy again - perhaps you've heard. Matteo Salvini has ratcheted up his signature budget bombast ahead of the EU elections and there's rampant speculation he may attempt to capitalize on League's popularity by forcing a government shakeup.
The bickering between League and Five Star is becoming wholly untenable and it's doubtful that Salvini wants to wait too long to make a move lest the Italian economy should decelerate anew and/or Italian assets succumb to another bout of turmoil on par with what we saw last May. Amid the tension, Italian stocks are on track for their first losing month of the year (bottom pane in the visual above).
Here's a bit of color from Goldman that gives you some perspective on Italy in the context of the recent risk-off mood (this is from a note out Tuesday):
In order to assess how the deteriorating macro picture has influenced performance, we benchmarked cross-asset performance to the recent changes of our first three GS risk appetite indicator factors: global growth, monetary policy and the dollar. We found that cross-asset performances since beginning of month have been in line with their implied return, except the Banks sector which has underperformed materially. 
Note that the FTSE MIB (i.e., Italian stocks on the whole) have actually performed inline with their implied beta, which means that things could get a lot worse for Italian equities in the event decent earnings are no longer sufficient to offset concerns about the banking sector, where exposure to the sovereign is actually running near historical highs.
To be clear, monetary policymakers are on high alert and will do what they can. The RBA minutes and a speech from Philip Lowe on Tuesday telegraphed a rate cut and the market still expects Fed easing. Meaningful ECB and BoJ normalization is out of the question for the foreseeable future.
Whether central bank accommodation will be enough this time around is debatable.
In case it didn't come through in all of the above, my current view is that there's not a lot to like about the setup right now.
Take that for what it's worth.