US-China relations updates
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A curious feature of the aftermath of the 2008-9 financial crisis is that there has been no backlash against international finance to compare with the retreat from globalised production. Still more curious is that global capital seems so unbothered by the Biden administration following Donald Trump in seeking to decouple economically from China.
This makes the wholesale dumping of Chinese bonds and equities by developed world fund managers earlier last week — in the face of Beijing’s continued assault on Chinese tech giants and its new attack on the Chinese private education industry — a striking about turn. Doubly so, given the sheer momentum of record inflows into China.
The stock of inward foreign direct investment in China has risen from $587bn in 2010 to $1.9tn in 2020. While global foreign direct investment fell last year by 35 per cent to $1tn, inflows into China rose from $141bn to $149bn, no doubt partly reflecting perceptions of a very rapid recovery from Covid-19.
Foreign investors also bought $35bn of Chinese onshore equity stocks and $75bn of government bonds in the first half of this year, in each case a 50 per cent increase over the buoyant pre-Covid levels in 2019. As for Chinese companies quoted in the US, until this month investors largely ignored the administration’s threats to delist those that fail to meet stricter audit compliance requirements. So, too, with prohibitions on investment in Chinese companies with links to the military.
Nicholas Lardy of the Peterson Institute for International Economics points out that global economic decoupling from China is simply not happening. Indeed, “in some critical dimensions China’s integration into the global economy continues to deepen”.
In part, that reflects the Beijing leadership’s commitment to gradual liberalisation of the financial system. Wall Street’s finest, mesmerised by the prospect of a Chinese crock of gold at the end of the global rainbow, have recently been encouraged by Beijing regulators’ relaxation of ownership rules to take controlling stakes in Chinese securities firms and fund management groups.
And by easing restrictions on bond and equity inflows the Chinese authorities have been helping relieve the solvency problems of overstretched American and European pension funds. Against the background of an appreciating renminbi, these investors have been finding more generous yields in China’s bond market than in the US or Europe.
Domestic and US-listed Chinese equities, meanwhile, offer access to a vibrant technology sector. Rhodium Group, a research company, estimates that US investors held $1.1tn in equities issued by Chinese companies at the end of 2020.
Last week’s market turmoil suggests that developed world investors have underestimated the importance the Chinese Communist party attaches to control and social stability. Beijing is bent on cutting tech titans down to size and gaining a tighter hold over data. Its tilt at the tutoring market is designed to make education less elite-friendly.
The leadership is also determined to block the efforts of the US Public Company Accounting Oversight Board to gain access to US-listed Chinese companies’ documents. Former diplomat Roger Garside suggests in his book China Coup that US threats to delist Chinese companies that fail to comply are not empty. He sees a risk that tensions over capital market issues could escalate seriously.
The scope for Chinese retaliation is equally real, notably in relation to so-called variable interest entities (VIEs), through which US investors gain access to Chinese equities. Beijing’s sudden ban on tutoring companies’ use of VIEs has highlighted the risks in an arrangement that confers only tenuous ownership rights and no control rights at all over onshore Chinese companies.
If greater hostility to foreign capital endures, China will pay a price. So far Beijing’s aspiration for the renminbi to be a global reserve currency has been well served by its liberalised financial markets. Yet the essential next step — capital account liberalisation — was always going to be a challenge for the party because it entails a loss of control. It will become even harder if there are reduced foreign inflows to offset capital flight unleashed by rich Chinese who have no trust in the regime.
The US and China have a mutual interest in continuing financial interdependence. But as with wider geopolitical competition, the risk is of friction becoming out of control. The global financial alchemy whereby the relatively poor Chinese help finance rich countries’ pensions is no longer a given.