Biden Xi meeting could slow but won’t stop fraying economic and trade ties for U.S., China

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JIMBARAN, Indonesia – This week’s one-on-one meeting between President Biden and Chinese President Xi Jinping may ease tensions, but is unlikely to stop a slow erosion of financial and economic ties between the States United and China.

The past five years of tussle between the US and China over trade, technology and Taiwan have led to a realignment that is playing out in financial markets and corporate boardrooms around the globe.

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 for invading Ukraine, according to the Institute of International Finance (IIF ). At the same time, manufacturers looking to strengthen fragile supply chains are turning to Vietnam or India instead of China.

“There’s a huge shift going on,” said Andrew Collier, an economist with GlobalSource Partners in Hong Kong.

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Business groups praised Biden and Xi for stepping away from open confrontation and said planned follow-up meetings between senior US and Chinese officials could herald further improvements. But, at least for now, the relationship between the world’s two largest economies appears to be stuck halfway between rupture and rapprochement.

The three-hour meeting on the Indonesian resort island of Bali was different from Trump-era summits, which have been dominated by trade and tariffs. This time, the US read the talks mentioned Taiwan and human rights in Xinjiang, Tibet and Hong Kong before referring to “continued concerns about China’s non-market economic practices, which harm American workers and families.”

For its part, the Chinese government dismissed notions of an inevitable conflict. Biden, who last month banned China from receiving US advanced computer chips and related equipment, assured Xi that the United States does not want to “decouple” from China or limit its economic development, according to China’s Ministry of Foreign Affairs.

“It starts a trade war or a technology war, building walls and barriers, and pushing to decouple and separate supply chains from the principles of the market economy and undermines the rules of international trade. Such efforts serve no one’s interests,” said the Chinese account of the meeting.

The session did little, however, to clear the clouds covering financial ties between the giants. Numerous investment funds this year, including public employee retirement plans in Florida and Texas, have reduced or eliminated their Chinese holdings.

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On Tuesday, S&P Global Ratings warned investors about the consequences if the United States were to impose Ukraine-style sanctions on China. With the Chinese economy several times larger than the Russian economy, the economic result would be enormous.

Barring Chinese financial institutions from using US dollars – perhaps in response to a future attack on Taiwan – could leave them unable to make the required interest payments on their bonds, S&P said. Of 170 bond offerings by Chinese banks, investment firms and insurance companies over the past three years, none allow repayment in a currency other than the dollar, the ratings agency said.

National security alarms mounted about investments that were once there have already cooled.

BlackRock, which manages more than $10 trillion in assets, has scrapped plans to market a new fund to invest in Chinese government bonds, fearing it would upset anti-China partisan sentiment in Washington, according to the Financial Times.

It’s easy to see why the firm balked: This week, the House Financial Services Committee held a hearing on the potential national security risks of allowing US funding to “competitors and foreign conflicts”.

If some investors are afraid of Washington’s reaction, others are worried about political developments in China. Tiger Global Management, an American investment firm, reduced its holdings of Chinese stocks after Xi last month broke with recent norms and began a third term as China’s president – leading some analysts to believe that he plans to rule indefinitely.

The company turned to Chinese investments because of rising geopolitical tensions and the economic fallout from a strict zero-covid-19 policy, according to a person familiar with the decision who spoke on condition of anonymity to discuss the company’s internal discussions. .

Following the recent 20th Congress of the Communist Party of China, investors are concerned that market-oriented economic development is no longer a priority for the government. Instead, Xi is expanding the state’s role in the economy and cementing 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 on Tuesday.

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Starting in 2019, foreign investors flocked to China’s bond market to take advantage of higher returns than they could earn in the United States. But in recent months, those flows have reversed.

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Foreign investors dumped about $70 billion into Chinese bonds over a four-month period starting in March, according to IIF.

Russia’s February 24 invasion of Ukraine and the Federal Reserve’s March interest rate hike have caused investors to rethink their positions, said David Loevinger, managing director of the emerging markets group for TCW. an asset management firm based in Los Angeles.

“At the [Winter] Olympic Games [in Beijing], Xi gave Putin the big bear hug and two weeks later, the tanks rolled,” said Loevinger, a former US Treasury Department official. “People were asking if China would be subject to sanctions. Certainly, that was a concern.”

Additional capital outflows would drag on China’s financial markets. But the bigger question is how companies are retooling their supply chains.

For years, US and other manufacturers were drawn to China by its low-cost labor. But recurring production disruptions during the pandemic convinced them to set up multiple supply lines, despite the added cost.

Companies are looking for other locations outside of China for a variety of reasons. The overall relationship between the US and China has steadily deteriorated. Due to repeated covid lockdowns, Chinese factories are less reliable. And because of Washington’s bipartisan hostility toward China, executives are wary of betting too heavily on a country that has fallen out of favor.

Among the companies that are ramping up production elsewhere is Apple, which will rely on India for an increasing share of smartphone output.

The Biden administration is also promoting efforts to reduce US dependence on China for key minerals, pharmaceuticals and electric vehicle batteries.

US imports from China today are below their pre-trade war trend, according to a recent analysis by economist Chad Bown of the Peterson Institute for International Economics. The United States now buys products like clothing and footwear from Vietnam that it once bought from Chinese suppliers.

While trade data shows no wholesale decoupling, direct investment across the Pacific is evaporating. Chinese investments in building or acquiring American factories peaked in 2016 at nearly $49 billion, before falling to less than $6 billion last year, according to the Rhodium Group, a New York-based consultancy. US direct investment in China has fallen from a 2008 peak of nearly $21 billion to about $8 billion in 2021.

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For now, the shift away from China appears to be about redirecting future development rather than a broad retreat from current footprints.

A third of US companies in China said they had directed new investment to other countries in the past year, nearly double the percentage that did so in 2021, according to a recent survey by The American in Shanghai. Only 1 in 6 companies are considering moving their current operations in China elsewhere.

“Xi Jinping’s clear signals about the contours of his administration’s economic policies, which will be less favorable to private enterprise, are likely to discourage US investments in China and lead to continued economic and financial decoupling,” said a former IMF official. Eswar Prasad, said. now professor of economics at Cornell University.

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To be sure, after four decades of growing US-China integration, the prospect of a complete divorce is slim. About $700 billion worth of goods will move between the two nations this year, up from last year’s level and more than six times more than in 2000, according to Census Bureau statistics.

Increasingly affluent Chinese consumers are critical to the profit hopes of US companies including General Motors and Microsoft.

Companies cannot easily replicate their Chinese production arrangements elsewhere. China’s ports, roads and rail networks are among the best in the world, complicating any plans to abandon the country.

“Unless there’s real political pressure, I don’t see it,” said Michael Pettis, a finance professor at Tsinghua University’s Guanghua School of Management in Beijing. “Once covid is behind us, what really matters is if you move manufacturing outside of China, you immediately become less competitive.”

Still, national security concerns are trumping pure economics in both nations. In Washington, the Biden administration is working on new regulations to restrict outbound investment to China. Xi wants China to develop more of the advanced technologies needed for military and commercial supremacy.

Expanding US-China commercial ties under these conditions will not be easy.

“Managing competing interests is difficult,” said Eric Robertsen, global head of research and chief strategist for Standard Chartered Bank in Dubai. “But we have to find areas where we can cooperate. It is in everyone’s interest that things go off the proverbial cliff.”

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