Playing the Geopolitical Blame Game
Author: Kevin McCreadie
May 20, 2020
U.S.-China relations are flaring up again. AGF’s CEO and Chief Investment Officer discusses the market implications and what investors can expect if tensions continue to intensify in the coming weeks.
How is the pandemic impacting the current geopolitical climate?
The biggest impact is probably the growing antipathy towards China and a feeling that the country’s government has not been transparent about its COVID-19 response—especially in the very early days of the outbreak. There’s also been accusations in recent days about Chinese hackers trying to steal vaccine research from U.S. drug manufacturers, which is fanning flames further and creates calls for reparations from China for the cost of the pandemic, threatening further disruptions to global supply chains. But this type of sabre-rattling isn’t new to investors. The U.S.-China relationship has been strained for several years now and markets have grown somewhat accustomed to it. Of course, that’s not to diminish the potential impact of these fresh tensions. The investor optimism and market relief that was evident after both countries agreed on phase one of their new trade pact late last year has clearly waned in recent weeks because of them.
Is the U.S.-China trade deal in jeopardy?
China has already said it may want to renegotiate the deal and antagonistic actions by the U.S., including an order to prevent a federal retirement savings plan from investing in Chinese companies, only complicates matters. So, it’s going to be a difficult process to keep the deal from derailing. In fact, even putting aside recent events, it has never been a sure thing given some of the obstacles that need to be overcome, including those related to technology transfers that were to be tackled in later phases. But as much as investors are focused on U.S.-China relations, they also need to be wary of trade tensions potentially flaring up elsewhere around the world. If you consider what has happened over the past few weeks, the pandemic has created a dynamic that is forcing countries to work more closely together and coordinate on policies such as border control that are integral to keeping the virus from spreading. At the same time, however, it has also fueled animosity which threatens to pull us further apart and accelerate the prevailing trend in recent years towards a more de-globalized economy. Perhaps the European Union is the best example of this, where some of the southern countries like Italy, which were hit first by the virus, feel like they are being treated unfairly by other countries in the bloc with regard to humanitarian and fiscal aid.
What does this mean for global supply chains?
Supply chains have already been disrupted considerably over the past few years, in part due to the increase in global trade tensions, but also because of advances in technology that have allowed some companies greater manufacturing independence. That said, investors shouldn’t be surprised if this disruption accelerates because of what’s happened in recent weeks. This will put China even more in the spotlight—especially if calls for more onshoring of production from the U.S. and other developed countries continue to grow louder. That doesn’t mean that investors should expect a manufacturing exodus out of China. Instead, it’s more likely that certain industries reduce their reliance on China as the main link in their supply chains by setting up supplementary production in other countries and/or back home. A good example is the pharmaceutical industry, which many believe is too dependent on Chinese production, or the technology chain as companies fear a greater backlash by both governments. To be clear, these types of changes don’t just impact China. The reliance on other global manufacturing hubs such as Mexico, Vietnam, India and others will also be tested as more companies rethink the concentration risk associated with their current supply chains.
You mentioned the threat of reparations against China. What does that entail?
Some people are saying China should be sued, but that seems far-fetched and very unlikely. It’s also been floated that interest payments be denied on U.S. treasuries that China holds. Again, this seems unlikely, in part because of the terrible message it would send to the broader fixed income market. A new round of tariffs is more likely if, in fact, reparations are forthcoming. And unlike the levies that were slapped on Chinese imports in the past, there’s probably more international support this time around. It’s not just the U.S. who feels that China has handled the pandemic poorly. Other than tariffs, the U.S. can enlist several other punitive tactics. Not allowing federal pension plans to invest in Chinese companies is one, and the government recently announced it will tighten export controls on Huawei, the Chinese telecom giant, and its suppliers. It can also be argued that the U.S. decision to halt funding to the World Health Organization (WHO) because of its “cozy” relationship with China is a form of payback. However, in this case, there’s almost zero backing from the international community which continues to recognize the critical role that the WHO plays in fighting against the pandemic.
Is the upcoming U.S. election influencing these decisions?
That seems without question. President Trump has been widely criticized for the way he has handled the pandemic both at home and abroad, and in many ways the election will be a referendum on his actions over the past couple of months as well as what he does next. That’s likely why he has been so aggressive in trying to get the economy re-opened and may also be why he has shifted the responsibility of the re-start to the governors of each state. If it backfires, he has them to blame, but if it’s successful and the economy fires up again, then he will take the credit. His attacks on China also run in the same vein. Not only are we likely to see this rhetoric increase, he may decide to frame Joe Biden, his Democratic opponent, as being friendly to China in order to up the ante. So yes, it’s a very politicized issue.
Kevin McCreadie is Chief Executive Officer and Chief Investment Officer at AGF Management Ltd. He is a regular contributor to AGF Perspectives.
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