US-China conflict echoes Europe’s past

Markets are much too sanguine about the possibility of de-globalisation

Rana Foroohar

Here is a story that should seem familiar. A great power, unsurpassed in military might and technological prowess, exports its free-trade economic model throughout the globe. Borders collapse, distance shrinks and the world seems smaller.

But market excesses and political dysfunction eventually lead other nations to question the wisdom of its approach, and another power rises — one whose dominance is built on a system of economic nationalism and industrial policy. As it flourishes, the first stagnates, sparking a conflict that leads not only to war, but to a decade-long decline in global trade and financial assets.

I’m referring of course to the last wave of globalisation involving Great Britain and Germany, which eventually died with the first world war and the Great Depression. It was a boom that lasted nearly eight decades, during which global trade and financial openness nearly doubled. Yet as the Bank for International Settlements put it in their 2017 annual report, “the collapse of the first wave was as remarkable as its build-up”, resulting in “an almost complete unwinding” of cross-border trade and financial flows.

Markets did not see it coming. And at the risk of being a Cassandra, I wonder if they aren’t just as oblivious to what is happening today with the US and China. The conflict between these great powers has obvious similarities to the earlier story, not just in terms of opposing economic models and rising nationalism, but also in the boom-bust timeline. It has, after all, been more than seven decades since the current wave of postwar globalisation began.

Stock markets, which took fright late last year, have recovered much of their losses. This happened, even though every day seems to bring a new harbinger of conflict that is much bigger than soyabeans, or steel, or tariff rates.

Two recent events have, for me, moved the market worry dial from yellow to red. First was the US request that Canada arrest and extradite Huawei’s chief financial officer followed by its decision to charge the Chinese chipmaker with espionage and sanctions violations. As investor Luke Gromen put it in his recent newsletter, the FBI has effectively declared “the official time of death of globalisation”.

The US also stepped up pressure on its allies to limit Huawei’s ability to do business in their markets — something that mirrors sentiment already brewing in places including Germany, which is once again pushing industrial policy and “national champions”.

This underscores the reality that the political impetus for deglobalisation does not begin and end with the Trump administration. It is no longer limited to the far-right or far-left. Most of the announced Democratic presidential hopefuls for 2020 — Elizabeth Warren, Kamala Harris, Kirsten Gillibrand, Sherrod Brown — appear to be coming around to the view that the economic relationship between the US and China will have to substantially change.

There are already a number of bipartisan legislative efforts around things like Chinese intellectual property theft and the spread of Chinese influence in the US. Curbing economic ties between the US and the Middle Kingdom is no longer considered “China bashing”, but has become a mainstream view.

The second thing markets should fear is the recent warning from a committee of Wall Street luminaries that advises the US Treasury. They estimated that the federal government is going to have to sell $12tn worth of bonds in the coming decade to fund its burgeoning national debt at a time when Chinese purchases of treasuries are falling.

Analysts have long speculated about what would happen if China stopped funding US debt. But now the question is coming to the fore at a time when there is more debt in the world than ever before. Global sovereign debt levels are far higher today than they were after the last round of deglobalisation following the first world war. Financial products have grown so much faster than the real economy that financial assets are now more than three times global gross domestic product, which of course amplifies the impact of any correction.

Deglobalisation is a complex, slow-burn process and not yet a done deal. But already, companies are under increasing pressure to choose whether they want to do business in the US, or in China, particularly in highly contentious areas like 5G networks. I recently asked Cisco chief executive Chuck Robbins whether he worried about the political implications of being a US company wiring up smart cities in China. “China owns the data, we just provide the infrastructure,” he answered, attempting to distinguish between the role of a private company and a state actor.

But that line is becoming tougher to draw. Over the next few months, as the US-China trade talks continue and the 2020 presidential race gets into gear, we may see shifts in cross-border supply chains and investment flows that once seemed impossible.

What will this mean for markets? Mr Gromen argues that “US corporate margins as a percentage of GDP could easily fall by 30-60 per cent just to return to the long-term range” that existed before China entered the World Trade Organization and sparked a trade boom.

Time to rethink investment choices and re-read history.

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