The US-China diplomatic relationship may be entering a new stage. The balance of power between the key players – Trump, China, the US Congress, and the Democrats – is changing and their roles are being reshuffled. This might be enough to break the endless cycle of agreements and re-escalations. In short, we think both Trump and Chinese officials have a greater incentive to reach a deal (or at least not to escalate) this time around.
Meanwhile, the rising antagonist force – the US Congress – will be busy shifting the conversation away from trade policy and towards issues such as civil liberties. If we are right, even partially, this would mean a more benign outlook for global markets and risk appetite, but it could also lead to proxy trade conflicts and collateral damage to other countries, most likely the EU and EM Asia.
Here is a non-exhaustive discussion of some factors, incentives, and constraints underpinning the US-China relationship, and how we see them changing:
- Trump’s incentive to escalate the trade conflict diminish as we approach the election. This is not to say that his trade war is over or that we will have no more setbacks, only that the chances of a benign outcome are increasing. Recall that a similar deal was struck in late 2018, but the truce broke down over “enforcement mechanisms.” What’s different this time around? Tump is under attack from all sides (impeachment, Ukraine, Turkey, emolument, etc.), so it’s fair to assume that his pain threshold to disruptions in the economy and financial markets is lower. Now he may be more amenable to Chinese demands and willing to accept symbolic victories, such as a vague currency agreement or intellectual property commitments, which he can spin in the elections.
- China’s hand has strengthened, and this might be the optimal time to play it. China has an incentive to negotiate now because it can set the terms, and because the future is highly uncertain this close to the US elections. Along with continuous constructive comments, China has already imposed a more assertive tone by conditioning the purchase of agricultural products on US reducing tariffs. But China knows there are limits to its leverage: the economy is slowing and is exposed to US exports, and it has other vulnerabilities to consider (e.g. Hong Kong and the Uyghurs minority). Moreover, it doesn’t want to stoke the rising trend of anti-China sentiment in the US that will feature prominently in this electoral cycle and might long outlast Trump’s presidency.
- The public opinion of Americans towards China has deteriorated, forcing the political establishment to react. According a Pew Research Center poll conducted between May and June, the share of Americans with an “unfavourable” view of China has increased from 47% at the start of the Trump presidency in 2017 to 60% now. But perhaps more interestingly, the increase since 2017 was driven more by Democrats (+18 ppts) than by Republicans (+14 ppts). It doesn’t matter whether Trump caused or responded to this trend; the point is that this just about assures that every elected US politician will be looking for opportunities to bolster their “hawkish” credentials against China. Recall that aside from the presidency, all 435 seats in the House will be contested, along with 34 of the 100 Senate seats.
- The US Congress has become a wildcard and Trump may have acted as a moderating force. We have just seen two rare displays of bi-partisan action from the US Congress, both with serious implications for Trump’s agenda: the measures against Turkey and the Hong Kong Human Rights and Democracy Act. In both cases, the legislative branch has taken the hawkish ground from under the executive. Trump is finding himself in the unusual position of having to act as a buffer against Congress as he fights to retain control over the foreign policy narrative. This is arguably what he did for Turkey by imposing sections that were far more benign than what Congress was proposing, then rushing to the region to broker the conflict. Trump may have to play the same buffering role vis-à-vis China if congressional activism starts to derail the trade talks or puts China in a position in which it is forced to retaliate.
- The Democrats have an incentive to escalate the conflict with China, but on a different agenda. We expect that the Presidential contestant, whoever it may be, will want to shift the debate away from trade and economics (where Trump arguably controls the narrative) towards issues closer to their platform, such as human rights, civil liberties, and the environment. We find Elizabeth Warren’s op-ed about Hong Kong in Foreign Policy magazine earlier this month as especially instructive. In this piece, she argues for an approach towards China that is more grounded in civil rights instead of “uncoordinated and often counterproductive tariffs.” Coincidence or not, the Trump administration has already started to protect this flank and bolster its human rights credentials by imposing visa restrictions on Communist party officials accused of repressing the Uighur Muslim minority in China.
- Constrained on China trade war front, Trump may seek other targets to continue his trade policy. Aside escalating against Europe, which is already taking place, most of the potential new targets are in EM Asia. Many countries in the region have been beneficiaries of the dispute against China through trade diversion and have received a boost in their exports to the US. The Treasury department has already done some groundwork by placing Vietnam, Singapore, Malaysia, and Korea on its “Monitoring List” for currency manipulation in its last report. Of this group, Vietnam looks especially vulnerable. The country’s exports to the US have skyrocketed, and it has attracted a larger share of global FDI during the trade war. FDI from China to Vietnam so far this year is nearly double the value of the total invested in 2018, making it a good place to fight a proxy battle. Here is a statement from Trump back in June: “Well, a lot of companies are moving to Vietnam, but Vietnam takes advantage of us even worse than China,” and it’s “almost the single worst abuser of everybody.”
Win Thin is a senior currency strategist with over fifteen years of investment experience. He has a broad international background with a special interest in developing markets. Prior to joining BBH in June 2007, he founded Mandalay Advisors, an independent research firm that provided sovereign emerging market analysis to institutional investors. He received an MA from Georgetown University in 1985 and a B.A. from Brandeis University 1983. Feel free to contact the Zurich office of BBH
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