A ‘great decoupling’ is under way between the incumbent superpower and its challenger
Diana Choyleva
© Bloomberg
Financial markets welcomed last month’s truce in the long-running trade war between Washington and Beijing. But the “phase one” deal should fool no one. By parking core US complaints, including China’s weak intellectual property protection, forced technology transfer and pervasive state subsidies, the ceasefire merely drew attention to the difficulty of reconciling two fundamentally opposed systems.
This comprehensive contest for supremacy between the two nations demands a fundamental rethink of the approach to global investment. Two issues stand out: which economic and political model offers higher returns, and where will the underlying assets be more secure.
China’s handling of the coronavirus epidemic only accelerates this “great decoupling” between the incumbent superpower and its rising challenger. The sluggish response by local officials, evidently petrified of delivering bad news to their all-powerful bosses in Beijing, has highlighted the shortcomings of an autocratic regime that is obsessed with stability.
Foreign companies will understandably be tempted to join those that have already shifted production to countries such as Vietnam and Mexico because of US tariffs and rising costs in China. Beijing, in response, can be expected to redouble its efforts to become more self-sufficient, if not dominant, in a clutch of high-tech sectors such as artificial intelligence that hold the key to future growth.
US policymakers recognise that the battle with China will be fought in the technology arena — hence the ban on Huawei and attempts to get the UK and other allies to deny the telecoms company a role in their new 5G networks.
Be it in technology, trade or finance, the bifurcation between the US and China will be long and messy, but two main macroeconomic consequences are clear.
First, global productivity will suffer as efficiencies in production are sacrificed for political advantage. Meanwhile, deepening mutual mistrust will slow scientific and technological co-operation.
Complex cross-border supply chains are being shortened. That has been reflected in a slowdown in world trade, as businesses respond to tariffs and anticipate more sand being thrown into the gears of global commerce.
Second, prices will rise. Initially, the impact of tariffs can be viewed as a relative price adjustment, with higher costs eating into US real consumer incomes. Researchers at the US Federal Reserve have confirmed such effects.
But as global supply chains are rerouted — not in one fell swoop but in a process taking years — cost-push inflation is likely to take hold. The cost of capital is also set to rise, especially if financial integration goes into reverse, preventing savings from being put to their best use. In short, stagflation is set to raise its ugly head.
What does all this mean for investors?
If harnessing and analysing vast troves of data is the most valuable asset in an age of information, then Alibaba and Tencent might look a better bet than, say, Amazon. That is because of the absence of data privacy laws in China and the support — explicit and implicit — that Beijing lends to its tech giants.
But there are broader considerations. Importantly, investors who see opportunities in the Chinese economic sphere should not take the continued relatively free movement of capital for granted. Beijing has pledged to open its financial sector to foreign capital and competition, but a digital cold war will make that goal immeasurably harder.
Moreover, in China’s communist regime, the owners of capital can be sure they will be the last in the queue when Beijing, like many governments across the globe, comes to address the pressing problem of income inequality.
Investors have long viewed China with suspicion because of government intervention. The fear that they might not be able to cash in their investments or pull their money out of the country has grown as president Xi Jinping has taken an authoritarian, Mao-style grip on power.
And then there is the exchange rate. If Beijing fails to lift productivity growth substantially through sweeping structural changes — a task that the Great Decoupling will make tougher — a weaker renminbi will eventually become the only policy valve left to relieve pressure on the economy.
More broadly, as two different systems of values clash, the danger of miscalculations and mistakes will grow. Against this background, the equity risk premium around the world — the excess return investors demand to compensate them for holding shares instead of risk-free assets — is set to rise.
No matter who wins November’s US presidential election, the schism with China is here to stay.
Patience with Beijing has worn thin across the spectrum of US political and public opinion.
That sets up an all-encompassing contest for dominance that will reshape the world political and economic order. Investors need a new road map to navigate it.
Diana Choyleva is chief economist at Enodo Economics in London
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