US, China relations entering Ice Age?

This article first appeared in The Edge Financial Daily, on July 24, 2018.
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KUALA LUMPUR: As US-China trade tensions continue to dominate headlines at the start of this reporting season in the US, there are concerns that the conflict between the two largest economies goes beyond trade and has more to do with race for global dominance between the two nations.

Pauline Loong, managing director of Hong Kong-based research consultancy Asia-analytica and also a senior fellow of CIMB Asean Research Institute, shared with The Edge Financial Daily that the differences between the two countries have gone beyond issues such as trade or investment or even intellectual property (IP) rights.

“This is a race for global dominance between China and the United States,” Loong said.

She explained that mutual interest had kept relations manageable between the two countries with American businesses keen to profit from a market of 1.4 billion consumers and China is still eager to gain access to American technology and break into the US-dominated global financial system.

Loong, however, cautioned that the perception is changing.

“The United States is treating China as an all-round threat rather than just a commercial competitor, and China believes that the US will try to contain its rise. So, even if there may be agreements in specific areas, the overall relationships will continue to be strained. Hence, the beginning of an ‘Ice Age’ in bilateral relations,” she added.

Her comments on the deteriorating ties between the US and China are consistent with reports that even some of Trump (US President Donald Trump)-themed flags and hats made in China were held up at US customs, affecting the sales of the Chinese manufacturers.

It is also worth noting that China’s manufacturers are considering moving to Vietnam and other low-cost countries in Southeast Asia on fears of the widening trade dispute between the US and China. The concerns arise as China’s stock market tumbled into a bear market last month while the Chinese yuan declined for the sixth consecutive weeks as corporate defaults appeared to be on the rise as well as of last Friday. The Chinese yuan has seen a slight recovery against the US dollar yesterday after Trump accused China and the European Union of currency manipulation on twitter over the weekend.

An economist with a local investment bank said that part of the conflict between the US and China stemmed from Beijing’s “Made in China 2025” vision, which is viewed as a confrontation against the US and some developed countries.

The stated objective of the programme, which was released back in 2015, is for China to become a major competitor in advanced manufacturing, a sector dominated by high-income, developed countries such as the US. Beijing’s administration acknowledged the need to move towards high-tech industries in order to escape the middle-income trap that has plagued many developing countries. “Made in China 2025” entails government subsidies, heavy investments in research and innovation and targets for local manufacturing content.

“In a way, it is quite unfair towards countries that want to access the Chinese market. Basically, the programme builds on earlier policies in China that required foreign companies which seek to access the Chinese market to either enter into a joint venture with or transfer technology to domestic firms. If they already have a manufacturing plant in the region or their home countries, they are still required to have a manufacturing plant in China. This would give them an advantage,” he said.

Danny Wong, Areca Capital Sdn Bhd chief executive officer, however, believes that the programme has been viewed negatively as a lot of the forecasts on China overtaking US as the world’s leading economy is based on the assumption that the current growth in China is maintained.

“I think a lot of the assumption is that China, as an advanced developing economy, will continue to grow at this rate, which will eventually overtake the US. It is still possible given its population, where domestic consumption alone could sustain its economic growth. However, there will come a time when China will become a developed economy and its growth will also moderate,” Wong said.

Wong believed that the longer-term risk to the market could be the rising debt-to-gross domestic product as it is a systemic risk in the event of default.

He pointed out the rising interest rates seen in the US and the potential slower growth in the event of a prolonged trade war between the US and China as risk factors.

“During the period of QE (quantitative easing), some companies were very aggressive in their borrowings as interest rates were low but with the rising interest rates seen in the US, they would be faced with higher interest charges and if revenue were to be affected by the prolonged trade war, some of these companies might have to face defaults,” Wong said. He, however, believed that it is too early to price in this risk at the moment, noting that the US Federal Reserves could still make a U-turn in their monetary policy in the event of a slower growth from the trade war between the US and China.

Wong’s view was shared by most of the local market observers who remain optimistic about the equity market this year. The FBM KLCI saw a recovery following a heavy selldown post-the 14th general election amid uncertainties surrounding the change of a new government for the first time since its independence more than 60 years ago as well as fund outflows from emerging markets as trade tension between the US and China escalated further.

Yesterday, the FBMKLCI closed at 1,757.96 points, an increase of 0.19% from its previous close and has seen an increase of about 5.6% from its recent low of 1,663.86 recorded in the first week of this month.