Investors pulled $8.8 billion from Chinese stocks and bonds in October, continuing an exodus that began after the United States and Europe imposed sanctions on Russia over its invasion of Ukraine, according to the Institute of International Finance (IIF). At the same time, manufacturers seeking to strengthen fragile supply chains are turning to Vietnam or India rather than China.
“There’s a huge shift going on,” said Andrew Collier, an economist at GlobalSource Partners in Hong Kong.
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Business groups applauded Biden and Xi for backing out of open confrontation and said planned follow-up meetings between senior US and Chinese officials could herald further improvement. But for now, the relationship between the world’s two largest economies seems to be stuck between break and rapprochement.
The three-hour meeting on the Indonesian holiday island of Bali differed from Trump-era summits, which were dominated by trade and tariffs. This time, the US reading of the talks mentioned Taiwan and human rights in Xinjiang, Tibet and Hong Kong before referring to “lingering concerns about China’s non-market economic practices, which harm American workers and families.”
For its part, the Chinese government rejected the idea of an inevitable clash. Biden, who last month banned China from purchasing advanced US computer chips and related equipment, assured Xi that the United States is not trying to “disengage” from China or limit its economic development, China’s foreign ministry said.
“Initiating a trade war or a technology war, building walls and barriers, and pushing for decoupling and breaking supply chains goes against market economy principles and undermines international trade rules. Such efforts serve no one’s interest,” the Chinese report of the meeting said.
However, the session did little to clear the clouds that enveloped the financial ties between the giants. Numerous investment funds have reduced or eliminated their Chinese holdings this year, including retirement plans for government employees in Florida and Texas.
On Tuesday, S&P Global Ratings warned investors of the consequences if the United States were to impose Ukraine-style sanctions on China. With China’s economy many times larger than Russia’s, the economic impact would be enormous.
Blocking Chinese financial institutions from using the US dollar — perhaps in response to a future attack on Taiwan — could prevent them from making required interest payments on their bonds, S&P said. Of the 170 bond issues by Chinese banks, investment firms and insurance companies over the past three years, none allow redemption in any currency other than the dollar, the rating agency said.
The mounting of national security alerts has already cast a chill on what were once routine investments.
BlackRock, which manages more than $10 trillion in assets, scrapped plans to launch a new fund that would invest in Chinese government bonds over fears it would collide with a bipartisan anti-China vote in Washington. said the Financial Times.
It’s easy to understand why the company declined: This week, the House Financial Services Committee held a hearing on the potential national security risks associated with allowing U.S. funding from “foreign rivals and adversaries.”
If some investors fear Washington’s reaction, others are equally concerned about political developments in China. Tiger Global Management, an American investment firm, reduced its Chinese stock holdings after Xi broke with recent norms last month and began a third term as China’s president, leading some analysts to believe he intended to rule indefinitely.
The company soured on Chinese investment due to rising geopolitical tensions and the economic fallout from Xi’s rigid zero-covid policy, according to a person familiar with the decision who spoke on condition of anonymity to discuss internal company deliberations.
In the wake of China’s recent 20th Communist Party Congress, investors are concerned that market-oriented economic development is no longer the government’s priority. Instead, Xi is increasing the state’s role in the economy and solidifying one-man rule.
“The biggest open question is whether China is a safe environment for foreign investors,” Carl Weinberg, chief economist for High Frequency Economics, wrote in a client note Tuesday.
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Beginning in 2019, foreign investors plunged into the Chinese bond market to take advantage of higher yields than they could earn in the United States. But in recent months, those flows have turned.
Foreign investors dumped about $70 billion in Chinese bonds in a four-month period from March, according to IIF.
Both the Russian invasion of Ukraine on Feb. 24 and the start of rate hikes by the Federal Reserve in March caused investors to rethink their positions, said David Loevinger, general manager of the Emerging Markets Group of TCW, a Los Angeles-based asset manager.
“At the [Winter] Olympics [in Beijing], Xi gave Putin the big hug and two weeks later the tanks rolled,” said Loevinger, a former US Treasury Department official. “People asked if China would be subject to sanctions. That was definitely a concern.”
Additional capital outflows would hamper Chinese financial markets. But the bigger problem is how companies are redesigning their supply chains.
For decades, the US and other manufacturers have been drawn to China for its low labor costs. But recurring production interruptions during the pandemic convinced them to set up multiple supply lines despite the extra costs.
Companies look to alternative locations outside of China for a variety of reasons. The overall relationship between the US and China has steadily deteriorated. Repeated covid lockdowns have made Chinese factories less reliable. And a bipartisan hostility from Washington to China makes executives wary of betting too heavily on a country out of favor.
One of the companies ramping up production elsewhere is Apple, which will depend on India for a growing share of smartphone production.
The Biden administration is also promoting efforts to reduce US dependence on China for key minerals, pharmaceuticals and batteries for electric vehicles.
According to a recent analysis by economist Chad Bown of the Peterson Institute for International Economics, US imports from China are currently below their pre-trade war trend. The United States is now purchasing products such as clothing and footwear from Vietnam that it once bought from Chinese suppliers.
While trade data shows no large-scale decoupling, direct investment in the Pacific is evaporating. According to the Rhodium Group, a New York-based consulting firm, Chinese investment in building or acquiring U.S. factories peaked at nearly $49 billion in 2016 before falling to less than $6 billion last year. U.S. direct investment in China has fallen from its 2008 peak of nearly $21 billion to about $8 billion by 2021.
For now, the shift away from China seems to be about redirecting future development rather than a broad retreat from an existing footprint.
A third of US companies in China said they had sent new investment to other countries in the past year, almost twice as much as in 2021, according to a recent survey by the American in Shanghai. Only 1 in 6 companies are considering relocating their existing operations in China.
“The clear signals from Xi Jinping about the contours of his administration’s economic policies, which will be less favorable to private enterprise, are likely to discourage US investment in China and lead to continued gradual economic and financial decoupling,” said former IMF official Eswar Prasad. now an economics professor at Cornell University.
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Certainly, after four decades of increasing integration between the US and China, there is little prospect of a complete separation. According to Census Bureau statistics, about $700 billion worth of goods will be shipped between the two nations this year, up from last year and more than six times what it was in 2000.
Increasingly affluent Chinese consumers are crucial to the earnings outlook of US companies, including General Motors and Microsoft.
Companies also cannot easily duplicate their Chinese production schemes elsewhere. China’s ports, roads and rail networks are among the best in the world, complicating plans to leave the country.
“Unless there is real political pressure, I don’t see it,” said Michael Pettis, a professor of finance at Tsinghua University’s Guanghua School of Management in Beijing. “Once covid is behind us, the only thing that really matters is that if you move production outside of China, you immediately become less competitive.”
Yet national security considerations overshadow pure economics in both countries. In Washington, the Biden administration is working on new regulations to limit outward investment to China. Xi wants China to produce more of the advanced technologies necessary for military and commercial supremacy.
Under these circumstances, it will not be easy to expand commercial ties between the US and China.
“It’s hard to deal with competing interests,” said Eric Robertsen, global head of research and chief strategist for Standard Chartered Bank in Dubai. “But we need to find areas where we can work together. It is in no one’s interest for things to go off the proverbial cliff.”