China-US relations: it’s complicated

3 June 2020

Investor sentiment has understandably been dominated this year with all manner of things related to Covid19. Now that the situation appears to have been brought under control in many countries, attention has started to refocus on some other issues. One such issue is the relationship between China and the US, the world’s largest economies. Another issue that will come into sharper focus over the next few months is the impending US presidential election. In this Macro Flash Note Daniel Murray reviews recent news flow with regard to these issues and highlights how they are connected.

US trade policy

President Trump was elected in 2016 on a platform that supported amongst other things a renegotiation of various trade relationships. After taking office the Trump administration initially focused on the North American Free Trade Agreement. Since 2018 the administration’s attention has turned to China, which it accuses of engaging in unfair trade practices. Over the past two years the US authorities have put increasing pressure on China, culminating in a series of tariffs on US imports from the country. The Chinese authorities have retaliated by imposing tariffs on imports from the US.

Chart 1. US trade Balance 12 Month MA

Source: US Census Bureau

Whilst the US does indeed import less from China than it used to, China has also reduced the value of goods and services it imports from the US. The net effect over the course of 2019 was a reduction in the US trade balance with China of around $75bn, about 18% of the end 2018 value. Proponents of the Trump administration will point to this as a measure of success. However, this was offset to a large extent by an increase of $53bn in the US trade deficit with other countries over the same time period - see Chart 1.

Recent China news

China was the first country to be affected by Covid19. Having imposed strict lockdown measures on the region that was the epicentre of the outbreak, the country has subsequently experienced a strong rebound in activity. The authorities are keen to ensure that the economy continues to improve and have imparted a series of monetary and fiscal policies to support the recovery, including:

- A RMB3.6trn fiscal stimulus package (about 3.5% of GDP)

- A RMB1.8trn expansion in the central bank’s lending and relending programmes targeting SMEs.

- A reduction in the Reserve Requirement Ratio of up to 200bps contingent on the type and size of bank

Table 1. China GDP Forecasts

Source: Bloomberg

Nonetheless, the situation remains highly uncertain. This is partly due to domestic economic concerns and partly due to economic fragility in the rest of the world. Because of this and for the first time since records began in 1990, the National People’s Congress that was held in May of this year did away with providing a GDP forecast for the year ahead.

Hong Kong gone wrong

One way in which the Covid19 crisis might have helped the Chinese authorities is with regard to Hong Kong. The Special Administrative Region has experienced widespread protests over the past 12 months following the Hong Kong government’s attempt to introduce a law that would have made it easier to extradite criminal suspects to the mainland. Despite this hugely unpopular legislation eventually being withdrawn, demonstrations have continued. However, the demonstrations were curtailed earlier this year due the combined impact of natural concern about the spread of Covid19 alongside official measures limiting the number of people that can meet in public.

Protests have once again erupted recently due the announcement that China plans to introduce a national security law for Hong Kong. Among other things, it is feared the law will restrict freedom of speech and other civil liberties.

The US reaction

The US authorities have subsequently said that Hong Kong is no longer considered autonomous from the mainland. By itself this decision does not particularly matter. However, it might be considered a precursor to the ending of Hong Kong’s special trading relationship with the US. This is important for two reasons: (i) it may damage Hong Kong’s position as a global trading hub (ii) it may damage Hong Kong’s status as a regional financial centre.

Whilst economists mostly agree that imposing restrictive trade policies on China results in negative consequences for the US economy, it is also true that there has been a rising tide of anti-China sentiment across US society over the past few years. As shown in Chart 2, such sentiment is common across both Democrats and Republicans and has grown in popularity.

Chart 2. Rising anti-China sentiment in the US

Source: Pew Research Center

One way in which to view recent US foreign policy is therefore in the context of the impending US presidential election. By talking tough on China, Trump is seeking to appeal to a broad array of voters from across the political spectrum as a means of bolstering his popularity.

Trump and his advisors are playing a dangerous game here. Talk without action might be seen as weak by some voters. Other than the removal of Hong Kong’s autonomous status, it is notable that the Trump administration has shied away from making any explicit statements about how they intend to punish China, despite having opportunity to do so. However, if actions follow that directly or indirectly harm the US economy, for example because of Chinese retaliation, that will diminish the chances of Trump being re-elected.

It is a delicate balance. Judging by the very limited response so far to Trump’s bellicose statements, it would appear the Chinese authorities appreciate the political nuances of recent US rhetoric.

In summary, this boils down to the balance between the US administration wanting to hold a hard line with the Chinese to increase Trump’s chances of re-election against both countries’ need to avoid another major trade dispute that could derail the fragile economic recovery.