For at least the first half of the 21st century, the US-China relationship will be the number one concern for investors, statesmen, global militaries and indeed, humanity in general. Things are not going to be easy. The US and the world have to face a number of realities, some of which I’ve discussed in past blogs but are worth repeating:
First, China with its 1.4 billion population and obsession with technology will, in the first half of the twenty first century, become the world’s largest economy. The US will have to deal with China as an equal. This rise of China will happen in spite of China’s aging work force. And it will happen even if, as seems likely, the statist, semi-closed Chinese economy remains behind the US in terms of total factor productivity growth and creativity. Size matters.
With a few exceptions, in building their models, economists tend to ignore such factors as a population’s work habits and levels of intellectual competence. These variables are not so easy to quantify and any kind of ranking will usually offend those groups ranked at the bottom. But in my opinion the Chinese people score right at the top in these areas. These qualities in its people will offset in part China’s sub-optimal communist state-directed economic system. Chinese emigrants, be they in Southeast Asia, the US, Canada or Australia, have been great success stories, often in the face of discrimination. The days of revolution and turmoil in China are now over and the Chinese can succeed in their own now imperfect but peaceful and progress-oriented country.
I have often joked that there is an important difference between China and India. In India, a person might hate his neighbor because he is of a different religion. But not in China. There, a person might hate his neighbor because the neighbor’s wife got the latest Louis Vuitton bag before his wife did. The Chinese are driven by material concerns, or at least that’s how it appears to foreigners. Investors love these kinds of people.
Second, China, with its 1.4 billion population and obsession with technology, will come to rival the US in terms of military power and will certainly become militarily equal to the US in East Asia where it has the “home court” advantage. This home court advantage is important. For example, the US has 12 nuclear-powered aircraft carriers. The Chinese are just now building their first combat-ready carrier. But as the press has reported, Chinese have “carriers” up and down the China coast. They are called airfields. And today’s unsinkable superships—the US carriers—like the once invincible battleships of old, are now vulnerable, this time to short-range missiles and, according to recent press reports, swarms of drones.
Third, take as a given China will seek to reassert its traditional dominance over East Asia and indeed all of Asia in general and push the US out. The US should not be surprised at this. Once upon a time in the 19th century, the US had its Monroe Doctrine warning European powers to not interfere with the Americas. And for centuries China had demanded and received subservience from neighboring countries under the so-called tributary system. The Chinese Belt and Road 21st century “Silk Road“ initiative, which includes building high-speed trains from China into Southeast Asia and building seaports in places like Sri Lanka, Pakistan and Djibouti, should be seen in this light. And we cannot forget China’s claims to almost the entire South China Sea under its so-called nine dash line geography. The Obama Administration stood by while China built up bases in contested areas. Asia, especially the Philippines, noticed.
In the twentieth century, Asians watched as the war-weary Europeans withdrew from their once enormous empires. The empires had become a burden. Asians watched as a psychologically-exhausted US withdrew from its Vietnam venture. But so much of the US high tech economy is now integrated with Asia, particularly in Japan, Singapore, South Korea and China itself. The US cannot afford to just leave as it did in Vietnam. Asia is a vital part of the US economy, not a burden.
Fourth, the Taiwan problem isn’t going to just go away. Right now because of its military inferiority vis-a-vis the US, China has been content to ignore Taiwan so long as the US adheres to the One China policy worked out in the Nixon Administration. But China’s patience on this isn’t going to last forever. For China, reunification of Taiwan is a Really Big Deal. As some point, China is going to be tempted to force reunification, by military means if necessary, as China grows militarily stronger.
From the US point of view, Taiwan reunification with China is also a Really Big Deal. Reunification could turn out to be a major economic disruption, if not a catastrophe. Taiwan, justifiably dubbed the “Silicon Island”, plays an extraordinary role in the global technological ecosystem. Apple (AAPL), Nvidia (NVDA) and Qualcomm (QCOM) for example are fabless (they don’t do their own manufacturing) and their semiconductors are designed in America but largely made in Taiwan. While the mutually ensured destruction nuclear standoff makes a full out war between China and the US unthinkable, a localized military solution to the Taiwan reunification problem may prove to be a rational solution for a China which in its own Asian region had become a military equal of the US.
There is an additional complication with Taiwan. The majority of people there, at least at present, apparently don’t want reunification with China. Taiwan is different from Hong Kong. Hong Kong was a British colony. Taiwan is a self-governing entity which de facto has functioned as an independent country. Nobody ever asked the people of Hong Kong if they wanted reunification. There was no plebiscite or election. In Hong Kong, its citizens had a choice—stay under China or leave. Many did leave. In Taiwan today, people can see there is a great deal of unhappiness especially among the young of Hong Kong with its current situation. Whether this unhappiness is justified or not is irrelevant. China had hoped that the Hong Kong model would prove attractive to Taiwan. But it has not.
Fifth, China has a long and impressive history going back thousands of years. But as I have argued in previous blogs, democracy with individual and private property rights is not part of the Confucian Chinese tradition. When the US took over from Britain as global hegemon in the twentieth century, at least the US and Britain shared the same values regarding democracy and personal and property rights.
Investors should be aware that even the top Chinese tech companies reportedly now have Communist committees inserted in their management structures. It was even proposed a few months ago that the government take equity positions in the major firms. The profit maximization model—the model in US textbooks under which firms are supposed to operate—may not be Beijing’s model. The highly successful big tech companies got big and powerful before the government realized what was happening. The government is catching up.
I’m not arguing to not buy Chinese stocks. Tech is moving fast in China and the opportunities in the Chinese markets are just too great. One third of the exhibitors at the just concluded CES 2018 in Las Vegas were Chinese. And Chinese companies are now joining the global tech market notably in places like Southeast Asia. The rest of the world is not going to share the anti-Chinese bias now being exhibited by the Trump Administration. Just be aware that not all decisions taken by Chinese companies may be with profit maximization in mind.
Sixth, reinforced by the Chinese Communist one-party state, the Chinese economy is based on the Confucian East Asian model which is highly protectionist. The US is going to have to work to change this. Unfortunately, there are no easy solutions for this. The US can retaliate by imposing tariffs on Chinese imports and restrictions on Chinese investments in the US. The US and China will both be the losers if the US goes down this route. The departure of arch-economic nationalist/protectionist Steve Bannon from the centers of power is good news. But the Trump Administration seems to be slowly creeping in the wrong direction and is imitating the protectionist Chinese models.
I regard as protectionist and harmful recent US actions against Chinese investment in the US. For example, pressuring AT&T (T) to not carry Huawei cellphones just means that US consumers will not be offered a cheaper alternative that is available to the rest of the world. And can anyone take seriously that there was a legitimate national defense rationale for the nixing of Alibaba’s (BABA) Ant deal with MoneyGram (MGI)? US regulators must remember that the argument that there are defense risks involved has problems. Unlike much of the past, technology is being driven by global civilian markets. Almost every tech product that was developed first for the civilian market has a military use. Policy makers have to live with this and not try to hold back the civilian markets.
Something the World Doesn’t Have to Worry About – US Debt to China
Recently a rumor spread that the Chinese were in the process of reducing their US Treasury position. The Chinese then denied this and the rumor was termed fake news.
Anyone familiar with international economics should have identified it immediately as fake news. Unfortunately, the majority of the global public and even financial types who should know better don’t understand international economics. China holds approximately $3.5 trillion in foreign reserves, a substantial portion, if not the bulk, is held in US Treasuries. In the popular view, the US is the supplicant, borrowing from China. But reality is not quite that way. In fact, it is China and its export-oriented mercantilist policies which have turned the US into its borrower.
China runs a huge trade surplus with the US. As a result, large amounts of dollars have flowed into the Chinese government coffers. The Chinese have had a choice—hold the dollars or let the renminbi rise against the dollar. So they chose to hold the dollars and keep the renminbi stable. And they had to invest the dollars someplace. Where else but in US Treasury securities. If the Chinese suddenly decided not to hold dollars and not buy US Treasuries, it would be up, up and away for the renminbi against the dollar. The Chinese certainly don’t want that.