TRADE WAR 2.0: BEYOND TARIFFS

At the beginning of the year, there were strong hopes for better relations between the US and China. The world’s two largest economies had signed a new trade deal with China promising to buy more American goods and better respect intellectual property, and the US cutting tariffs on some Chinese goods in return. Although the deal was less ambitious than initial expectations, many hoped it would prevent further escalation in an increasingly bitter trade war.
That, however, was before the coronavirus pandemic. In common with much of the developed world, the US has been badly affected by Covid-19, with the Trump Presidency seeing a rapid rise in unemployment and the quickest stock market sell-off in history. In order to cover for his Administration’s poor federal response, Trump has sought to deflect attention by blaming China for the virus.
Bilateral relations have been further inflamed by protests in Hong Kong, where the Chinese authorities have taken a hard stance against demonstrations and recently passed a new security bill allowing Beijing more control over Hong Kong. As a result, the US Secretary of State, Mike Pompeo, has followed through on threats to remove Hong Kong’s special trading status with the US.

A quick primer on Hong Kong

While Hong Kong has witnessed protests before, recent demonstrations have been some of the most disruptive on record. The protests started in June 2019 over plans to allow extradition from Hong Kong to the Chinese mainland. While some argue that there is a need for this law, the protestors saw this as undermining the greater degree of freedom that Hong Kong citizens enjoy compared to their mainland counterparts.
Over the course of eighteen months, the demonstrations escalated with many protestors demanding universal suffrage, a red line for China’s authoritarian regime. In recent weeks, the Chinese authorities have acted to impose further restrictions on Hong Kong, effectively banning criticism of the Chinese Communist Party, and sparking counter measures by countries such as the UK to offer refuge to Hong Kong citizens.
The US decision to remove Hong Kong’s special status means that exports from the city will face tariffs just as the rest of mainland China. In recent days, Trump has also signed legislation allowing for sanctions against businesses and individuals seen to be restricting freedom in Hong Kong. While both moves will ultimately make little difference to the broader Chinese economy, hopes for an end to trade tensions at the start of 2020 have clearly foundered.
Issues around Hong Kong’s future status have clearly had an impact on the local stock market over the first half of the year, with the market the worst performer across Asia Pacific. Many investors in the region appear unconcerned, however. The city remains an important gateway for Chinese companies wanting to access international finance, with the Chinese authorities likely to proceed cautiously.
In addition, the city could also benefit from Chinese companies choosing to move their stock market listing back to a domestic exchange, rather than an overseas exchange where they may not be able to access investor capital as freely. Prominent Chinese companies such as Alibaba (effectively the Chinese equivalent of Amazon) have already listed their shares on the Hong Kong exchange as well as listing on the US market, largely in response to US threats.
Could Hong Kong spark a renewed trade stand-off?
Unless we see a sharp escalation in tensions, however, it seems that the impact will be more muted. Trump also appears worried about damaging the existing ‘phase one’ trade deal between the two countries, especially over issues such human rights. In a recent interview with US news website Axios, Trump claimed that the reason he had not responded to abuses against Uighur Muslims was because he was in the middle of a major trade deal at the time.
Ahead of the 2020 Presidential election, Trump appears to be caught between two impulses. On the one hand, he wants to distract from his handling of the pandemic, with a lacklustre federal response and second waves of cases in Republican dominated states such as Arizona. On the other, he needs to defend the deal he struck with the Chinese government as recently as December last year, making it difficult for him to risk any serious escalation with the Chinese authorities.

Conclusion

In the short term, US-China relations will continue to be a source of market unease. The latest incident occurred with the US ordering China to close its Texas consulate, ‘to protect American intellectual property and Americans’ private information’ according to the US State Department. China has threatened retaliatory measures unless the decision is reversed.
Over the longer term, this tension and competition between the US and China may be something that investors simply have to get used to. ‘Made in China 2025’ is a strategic plan for China to move up the value chain in manufacturing, for example, with the country aiming to both make and develop more advanced technologies.
Made in China will naturally bring it into conflict with the US, with both countries seeking to preserve and gain any technological edge they can. This may lead to further sanctions around companies such as Huawei, with the American authorities restricting Huawei’s access to key American designed products such as semiconductors. Trade risks will likely become a risk that analysts will need to take into account when assessing potential investments.
Investors should not lose sight of the potential opportunities that China offers however. Trends such as rising domestic Chinese consumption remain intact and can be a powerful driver of investment returns. Given the uncertainties surrounding developed market assets, any source of future growth should not be overlooked, particularly given the outperformance of Chinese markets in the second quarter of 2020.

Written by

Carly Moorhouse
Fund Research Analyst

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