The US and Europe are set to isolate China as Australia allows it to occupy its sphere of influence in the Solomons. The cowards of Canberra are beyond reproach.
Nearly two months into the Russia-Ukraine war, US policymakers – troubled by Beijing’s pro Kremlin rhetoric – are forging ahead with robust plans to accelerate US-China decoupling. Of the five major decoupling pathways being explored today, two – the likely acceleration of the start of the process to delist nearly 250 Chinese firms on US capital markets by one year to 2023 and a first-of-kind US outbound investment screening regime – are currently included in different versions of the top-priority, bipartisan China competition bill that has favourable odds of being passed by mid-year. Two more pathways have the growing backing of the Biden administration, as evidenced by Treasury Secretary Janet Yellen’s pointed warning to China last week that its continued fence-sitting on Russia will jeopardize further global economic integration. Barring an unlikely U-turn by Beijing, the upshot is that the decoupling of the world’s two biggest economies will gather speed over the next three to 18 months – likely unleashing bear market risks for both China’s economy and US equity valuations – that will be reinforced as the EU charts its own decoupling path by mid-decade.
Investor attention to date has largely focused on the first pathway for decoupling: the potential delisting of an estimated 248 Chinese firms from US capital markets under the 2020 Holding Foreign Companies Accountable Act (HFCAA) for failing to allow full access of their books to USapproved auditors. Notwithstanding recent signs that Chinese regulators may be softening their stance, we expect an eventual delisting of key high-profile firms as an inevitable by-product of Beijing’s own data security concerns. Under a provision in the China competition bill, the start of this delisting process is set to be brought forward to next year (from the 2024 timeline set by HFCAA); its likely inclusion in the final bill would fast-track an initial rerouting of investment flows.
However, alongside this measure, investors should monitor four other overlapping mechanisms that could further quicken the pace of decoupling ahead:
1 The potential inclusion of a US outbound investment screening regime in the China competition bill (or a similar bill). Such a regime would be unprecedented in the US, although it has been billed as the reverse counterpart of the Committee of Foreign Investment in the US (CFIUS), which reviews foreign investment transactions. This means that the devil will lie in the details; for example, a broadly targeted regime could cover more than 40% of US FDI transactions in China over the past two decades. Not surprisingly, the business sector has lobbied heavily against this initiative. However, political support for such a regime has grown post-Russia invasion, giving the provision a real shot at making it into the final China competition bill.
2 New actions from the office of US Trade Representative Katherine Tai that could target “Made in China 2025” sectors (e.g., AI, EVs, renewables, robots). Tai recently affirmed that the US plans to take additional steps against China, after her office released a March report that warned that Beijing had “doubled down on its harmful trade and economic abuses”. This could include a new Section 301 probe into Chinese industrial subsidies, with an investigation likely to take 12-18 months, after which new tariffs could be levied on top of already existing tariffs from Trump’s trade war.
3 Measures curtailing the ability of US banks and other asset managers to invest in Chinese tech and related firms. Alongside legislative action, Biden can enact these restrictions via executive order – a move already backed by national security officials, albeit opposed by Treasury and the Commerce Department. Here, it is Beijing’s next steps that could determine whether these steps are adopted by the administration. Yellen’s recent warning to China suggests that even Treasury officials are now losing patience.
4 “NATO for trade”. Since 2020, there has been talk in Washington policy circles about the benefits of creating a new trade body for free market democracies that would lie outside the WTO framework and could support countries that have been targets of China’s wrath in trade (e.g., Australia, Lithuania). This idea has gained newfound impetus following Russia’s invasion. Any signs that it is making further headway at home and abroad could pave the way for the initial outlines of how the global geopolitical re-ordering will be redrawn in years to come.
Global fractures are deepening, four years after the starting gun fired by Trump’s US-China trade war, with top losers likely to include China’s economy and US equities. Our China economist Rory Green estimates that a decoupling scenario similar to that outlined above could add a 1-2 ppt drag on potential Chinese growth over the next 5 years to yield an average 3-4% annual GDP rate on our TSL measure (vs 5-6% in consensus mainland forecasts), with downward risks if an accelerated decoupling takes place (e.g., a EU/Northeast Asia split from China too). Meanwhile, our chief economist Charles Dumas warns that as deeper fracturing gets priced into the market, this will slash CAPE (using a 7.5 year cycle-length) and thus US equity valuations from an inflated 32 in Q1/22 (if down from 34 in Q4/21) vs a post-Cold War average of just over 25 and under 14 from 1914-91. As decoupling accelerates, can a bear market be far behind? For more on the principles of our CAPE analysis, and for why the EU is likely to decouple from China as Tech shocks to come in Cold War 2.0.
Goldman is more circumspect but its global views do not account for liberal versus illiberal trading blocs which is the future:
Many commentators expect the world to deglobalize following the US-China trade war, the pandemic, and the invasion of Ukraine. We take a longer perspective and ask if globalization—the growth in cross-border movement of goods, capital, people, technologies, data, and ideas—has already started to reverse.
Despite a rapid 2021 rebound, global goods trade has edged down by 4pp as a share of global GDP since the GFC, largely due to a fall in the trade intensity of China output.
Cross-border flows of direct investment and equity portfolio investment have declined sharply relative to global GDP since the 2000s, although these investments have edged higher on a cumulative stock basis. Similarly, net immigration flows in advanced economies have trended down over the past decade, but the population share born abroad has edged up further. Global tourism exports trended up until the pandemic collapse in 2020.
Exports of computers and communication services as a share of GDP have risen steadily, while cross-border data flows have continued to surge.
Taken together, the term slowbalization—slowing growth in cross-border moves—better describes trends for goods, capital, and people over the past 10-15 years than deglobalization—outright declines in cross-border flows and stocks. The surge in digital cross-border activity also supports the notion of newbalization, where globalization slows in tangible areas but accelerates in intangibles.
The big one is capital flows into China. It is these that are allowing it to manage its “impossible trinity” of controlling only two of three macro inputs of interest rates, currency value and capital flows.
Once the West bans capital flows to China it will enter a debt crisis that will shock its economy to the core.
It will hurt us too with higher interest rates but nowhere near as much.
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
