America’s willingness to deploy its reach through sanctions and tariffs poses some difficult questions for China. Its economic policy has emphasised control, but new strategies are now needed. China is being forced to build up the ‘soft power’ necessary to tackle its muscular rival.
Increasing China’s financial power requires continued progress on opening its financial markets, alongside the internationalisation of the renminbi. China’s efforts to internationalise the renminbi involve the full liberalisation of China’s capital account, including promoting capital account inflows. There is a significant opportunity to increase the status of the renminbi as a global reserve currency, particularly as there is debate on the US dollar’s leading position given America’s large current account and fiscal deficits.
Figure 1: Offshore renminbi deposits (US$ billion)
Source: Bloomberg, Investec Asset Management calculations. Offshore RMB deposits held in Hong Kong, Singapore, Taiwan, South Korea and United Kingdom. As at 30.06.19.
Renminbi deposits in various offshore financial hubs grew steadily from zero at the start of the decade and a sizeable drawdown followed a peak in 2015. Recent years have seen the fairly flat accumulation of offshore renminbi deposits.
The continued internationalisation of the renminbi relies on domestic financial market reform and increased investment into China’s onshore bond and equity markets. The stock and bond connect schemes are examples of such initiatives, with the most recent example being the Shanghai launch of the Science and Technology Innovation Board, or the ‘STAR’ market, that has similar rules to the US Nasdaq market to attract international investors. In September, China’s State Administration of Foreign Exchange decided to remove quota restrictions on two major inbound investment schemes, namely its dollar-dominated qualified foreign institutional investor (QFII) scheme and its yuan-denominated equivalent, the Renminbi Qualified Foreign Institutional Investor (RQFII). It said that the easing of restrictions would “make it much more convenient for overseas investors to participate in China’s domestic financial markets.”
By increasing its financial power like its adversary, China’s financial markets will become less insulated from world events, and more determined by the disciplines of the market. However, it’s clear that currency can also be used as a ‘soft power’ negotiating tool given it is a key determinant of international competitiveness, particularly in exports.
Building technological supremacy
Many of China’s leading technology firms have historically eschewed Chinese exchanges, given the volatility of its domestic equity market. It seems highly likely that China’s new policy on listing China depository receipts domestically could encourage many of its technology companies to obtain either primary or secondary listings on domestic exchanges. This will allow China-based investors to benefit from exposure to the most dynamic area of its economy, while also placing these firms further away from the reach of potential geopolitical rivals.
The launch of the Science and Technology Innovation Board, or the ‘STAR’ market, encourages technology companies to list at home, with significant potential for new listings. It is expected there will be a shortened time for the listing process, with a registration-based listing system, as opposed to a government regulatory approval model applicable to the main boards. It has similar rules to the US Nasdaq market to attract international investors.
Figure 2: Greater China IPOs in 2018 by stock exchange
|Hong Kong main board||Hong Kong GEM||Shanghai A-Share||Shenzhen SME Board||Shenzhen Chinext||Taiwan||Total|
|No. of IPOs||143*||75||57||19||29||31||354|
|% of total||40.4||21.2||16.1||5.4||8.2||8.7||100|
|Funds raised (US$ billion)||36.1||0.7||12.7||3.3||4.2||0.5||57.5|
|% of total||62.8||1.2||22.1||5.7||7.3||0.9||100|
Source: PwC research. *including listing by introduction and switch from GEM to main board without raising funds in Hong Kong: 13 in 2018.
The tools wielded against technology companies ZTE and Huawei will also concern China’s leaders. They will no doubt re-double their efforts to grow China’s indigenous technology industries. However, this could further irritate the Americans. It may also increase capital and operating costs, and potentially lead to the balkanisation of technology, between competing Chinese and American standards. For the Chinese, all this would likely feel unfortunate, but they may believe they have no alternative if they want to avoid periodic power struggles with the US. This could cause significant disruption across technology supply chains in Asia, America and globally.
China unlikely to cede its culture
Tensions between China and the US are complicated by mutual incomprehension. The Chinese have never dealt with someone like Donald Trump before. Clearly, the US does not understand China either. China’s culture is completely distinct from that of the West. For example, Chinese politicians often mention ancient philosophers in their speeches (such as Confucius who died 2,500 years ago), but these philosophers are arguably still relevant given that Chinese civilisation has remained recognisably intact for at least as long.
It would be realistic to expect China to abide by recognisable rules of good conduct, such as those on intellectual property. Its focus on innovation and the push towards intellectual property protections is reflected in the double-digit growth in patent applications (figure 3). However, it is naïve to expect China to transform into a clone of Europe or the US. This makes China difficult to deal with from a Western perspective.
Figure 3: Total China patent applications continue to soar
Source: WIPO Statistics Database, May 2019.
There is a darker school of thought around China and US rivalry, and this is the idea of ‘Thucydides’s Trap’. This argument dates back to Ancient Greece and states that when a rising power causes fear in an established power, the result will be an escalation towards war. While this is a possibility, in our view it is highly unlikely, as a war would not further either superpower’s interests.
Reaching a new equilibrium
We believe US-China trade tensions are likely to persist, waxing and waning in their intensity. China’s economic success has created a new strategic competitor to the US, and one that the US is now forcefully responding to with its ‘soft power’ arsenal. An extended run of trade conflicts could be debilitating for the global economy.
We are likely to see a prolonged period of adjustment, which is likely to be uncomfortable for investment markets, which continue to be roiled by the ongoing repercussions from the global financial crisis and the unorthodox economic policies instituted in its aftermath. As the Ancient Romans, or perhaps the Ancient Chinese, might have said: ‘Caveat Emptor’.