Unintended consequences of the Sino-US trade conflict (part 1)

24 Oct 2018

China could gain greater political cohesion

While many observers see China as the underdog in its trade conflict with the US, Chinese President Xi Jinping said “China can come out of the trade war in better shape than the US”.  His words may well have summarised an unintended consequence for China of the trade friction – President Xi may gain more domestic political capital which could facilitate his structural rebalancing efforts for the country and pave the way for developing the renminbi as an asset class in the medium term.

From blaming…

Any attempt to fully assess the impact of the trade dispute on China’s domestic development and foreign engagement must take into account the relationship between its middle class and the Chinese leadership.   Since early 2018, especially after Mr. Xi scrapped the presidential term limits in March, China’s middle class has been critical of his economic and socio-political policies, including the way the leadership has handled the Sino-US trade relationship.

The economic elite has reservations about Mr. Xi’s support of the state sector, which has manifested itself in the lack of progress on state sector reforms and resulted in crowding out many private firms. In this group’s view, the market reform plan outlined at the Third Plenum of the 18th Party Congress in 2013 has yet to materialise.

Two recent high-profile events further heightened discontent among the middle class. One was the collapse of the online peer-to-peer (P2P) lending market in June-July 2018, which wiped out almost 7 000 platforms and affected hundreds of thousands of middle-class investors. The second occurred in July-August 2018: the scandal of defective vaccines for diphtheria, tetanus and pertussis, which were prescribed to nearly half a million children. When the trade conflict with the US arose in June 2018, Chinese social media launched a new wave of criticism against the Party leadership.


…To shifting blame

Nevertheless, the views of China’s middle class, which have become the foundation of public opinion, might be poised to turn in the Chinese government’s favour. Any further rise in Sino-US trade tensions could result in a shift of blame to the US, as many Chinese now believe that the true goals of Donald Trump’s trade tactics with China are not only to undo what he sees as China’s unfair trade practices, but also to disrupt China’s overall development model and its aspirations to become a major global power.

While in the past, only a few conservatives warned of US attempts to ‘contain’ China, now almost everyone in China – including the middle class – buys into this narrative. Having grown up amid prosperity and confidence and having been exposed to western lifestyles, China’s middle class was supposed to usher in an era of more openness and freedom. It thus had much warmer feelings towards Western countries than the older generations. But their faith in Western ideals has now been shaken by Trump’s actions.

Two major events in recent history may ultimately be enough to tip support in favour of the Communist Party. They are Japan’s ‘lost decade’ of economic growth in the 1990s and the collapse of the Soviet Union in 1991.  Many Chinese believe that both episodes were results of an American conspiracy. Fear of a similar plot against China, in the guise of a trade war, has become prevalent.


The unintended consequence

A Sino-US trade war may thus serve as the catalyst for bringing about political cohesion in China. Mr. Xi may even gain more political capital in support of his structural reforms as different interest groups unite against a common foe. Even as China continues to open up to the world, the trade conflict with the US will prompt it to look increasingly inward at its domestic market for growth, innovation and technological advancement.

Trump’s trade war tactics may be about penalising China for its trade practices or containing its ascent on the global stage, but it has also pushed China to fortify itself for a new era of challenges. Over the longer term, reducing its reliance on foreign trade and imported technologies will likely strengthen China to the point where it has less need to follow a US-led regime. This, in my view, is what President Xi meant when talking about China coming out of the trade war stronger. Trump’s ‘Make America Great Again’ policy may end up with the unintended consequence of also making China ‘great’.

From a financial market perspective, I believe it is unrealistic to expect a resolution to the Sino-US trade conflict anytime soon. In my view, the market only needs to see the two sides agree to negotiate. Investors will then get on with life. Together with China’s opening-up policy, the unintended consequence may help facilitate the development of the renminbi into an asset class faster than it would have had there been no trade war.

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher than average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity, or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.