- Attrition as the road to agreement
- The tussle over tech (and winners and losers)
- A renminbi rout, cut-up supply chains and other consequences
China aims to wear down the US
We believe there will be no final settlement of China’s trade dispute with the US for a long time. The ultimate economic problem lies in the global imbalance of savings and investment: China leads in the east with surplus savings and under-consumption, while in the west, the US stands out with a savings deficit and over-consumption which has left it with trade deficits with over 100 countries. A bilateral trade war with China cannot solve the deficits with the rest of the world.
Any short-term agreements signed will likely serve to set the stage for further negotiations. China’s approach is to engage in a prolonged (almost serene) fight with the US, even at the cost of more domestic economic pain. It aims to exhaust the US with a rotating, and composed, tactic of fighting and negotiating – after each round of fighting, China will negotiate; if the negotiations fail, it fights again; and then negotiate and then fight… This steady cycle goes on until the US is worn down and comes to an agreement. Beijing will up the ante after each round of failed negotiations to make the settlement conditions tougher.
Trade war focus shifts to tech
The trade war is mutating, in my view, from a macro risk of economic imbalances to a micro risk of cut-throat technology competition. The latest flash point was a May 2019 bill by US Congressman Jim Banks to bar US pension plans from investing in Chinese assets. Since the House of Representatives has not reacted to the bill for over 180 days after it was proposed, this usually means the bill is dead by now.
More crucially to the development of the trade war is the Washington’s ban on US sales of technology to Huawei. However, instead of strangling Huawei, the ban has prompted the Chinese tech giant to act so that it can survive without US chips. US tech suppliers appear to have turned out to be big losers.
There are pressures from Congress to keep Huawei permanently on the ‘Entity List’ after its addition in May 2019. The US is also laying the foundations for future bills to force Huawei and other Chinese firms out of the US 5G system and bar them from the US tech market.
However, Huawei has defied such US pressures and continues to make smartphones and develop 5G base stations without US chips. Its Mate 30 smartphone, released in November 2019 and a rival of the iPhone 11, contains no US chips at all. Huawei has shifted away from US parts more quickly than expected. This has left US companies facing a growing substitution risk in markets in China, wider Asia and other emerging countries.
Tech squeeze has displaced supply chain
China’s drive to shake off its dependence on US parts goes beyond smartphones. Huawei can now build 5G base stations, which are a key part of the infrastructure needed for the high-speed network, without US components. The US strategy of isolating Huawei seems not working.
Huawei’s strategy to go independent of US supplies is simply switching to other, especially European and domestic, chip suppliers. Dutch NXP Semiconductors and HiSilicon (Huawei’s in-house chip design firm) have been the biggest winners so far at the expense of a big loss of Chinese business by US firms including Qualcomm, Intel, Qorvo, Skyworks Solutions, Broadcom and Cirrus Logic. With the trade war fought mainly in the technology sector, any companies and industries that are involved in the global supply chains that are connected to China will likely be affected.
Devaluation, decoupling, de-globalisation
Further rise in trade tensions in the short term may prompt China to scale back its currency intervention and allow the renminbi to weaken further under market forces as part of the negotiation tactics. This does not mean that China has a devaluation policy, but it does imply that the tail risk of the trade war igniting another round of currency war has risen.
In the longer term, the US effort to decouple from China by breaking up the global supply chains could be quite disruptive to the world’s production ecosystem. Broken supply chains will be inefficient, turn the clock back on globalisation and reverse the trend of disinflation.
De-globalisation will likely also result in financial fragmentation, which would disrupt the global technological landscape. Restrictions on technology transfers and linkages, for national security reasons, would give rise to competing and non-compatible standards, which would lead to excessive competition, hurt innovation and push up costs, and lead to slower adoption and even inferior products.
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Ay views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.
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