The contentious state of US-China relations

Last month, Morgan Stanley hosted its China BEST conference in New York and the topic du jour was, of course, the current state of the US-China relationship. Despite daily news headlines addressing the “trade war,” keen market observers have likely deduced by now that underlying the US-China tension is not trade or even economic policy, but rather the core national interests and security concerns of the world’s two preeminent superpowers. Bearing this in mind, a timely resolution to the “trade war” seems an unlikely scenario, as the US allegations in contention strike at the very heart of China’s national identity.

Short history of four decades of relations

The last four decades of relations between the US and China can be described as an era of engagement – not devoid of competition and friction, but both sides believed that friendly co-evolution was in their mutual interest. This of course did not stop China from abusing the uneven playing field created by the vastly different political systems and market structures. Indeed the four “pillars” of unfair trade practices identified by the USTR Section 301 investigation in March 2018 – being forced technology and IP transfers, illegal licensing requirements, state-directed outbound M&A and investments targeting key US industries, and allegations of cyber-enabled theft – were all decades in the making and it was inevitable that the US-China relationship would turn contentious at some point.  Trump simply took a firmer stance against China than previous administrations and leaned hard on tariffs as a negotiating tactic.

What was interesting to observe at the conference was the difference in attitude between those participants aligned with the administration and the non-partisan private sector participants. The administration’s outward position appears more conciliatory – to set the relationship between the US and China on a fairer and more constructive course, rather than to contain China’s rise. Substantive progress has already been achieved, for example on foreign investment legislation, IP protection, reduction of Chinese auto tariffs and increased agricultural purchases from the US, but the issue of enforcement was a stumbling block and China has a poor history of following through on trade and reform commitments.

A more prevalent private sector view is that the US is not demanding fair trade of China but rather managed trade that allows the US to unilaterally reimpose tariffs or other enforcement mechanisms without retaliation should China fail to follow through on its (largely US-determined) commitments. As one private sector speaker contended, “Beijing cannot and will not satisfy US demands unless it surrenders its quest for national greatness.”

From the Chinese perspective, such demands would be construed by hardliners as an attempt to contain China’s rise as a great power. Actions such as putting Huawei on the entities list do nothing to assuage this concern, and further erodes trust in any US attempts at rapprochement. While it is technically true that placing Huawei on the entities list was punishment for alleged violation of US export control sanctions wholly separate to the trade-related issues, there is no doubt that targeting China’s national technology champion is intended as both a bargaining chip for Trump’s negotiations and a warning to China’s national ambitions.

Where is the US-China relationship heading?

Given the nebulous nature of the relationship between US and China, and Trump’s own unpredictable agenda, it is unsurprising that there is no firm consensus as to where the US-China relationship is heading. Economic and political considerations may compel both sides to make compromises, but it is unlikely either side will compromise on core national security concerns mainly related to technology and industrial policy. With the 2020 presidential election approaching, China may try to draw out the negotiations to maximise its leverage. After all, Trump likes a rising stock market and doesn’t want a recession during an election year.

Trump may have a fallback position where he frames the negotiations solely around trade and strikes a face-saving deal that addresses the trade deficit but none of the underlying substantive issues. Such a deal may face substantial blowback from China hawks in the administration and inevitably be spun by the Democrats as a compromise on America’s national security, one that kicks the can of contentious issues down the road. Unfortunately for Trump – and despite what he may believe – he did not flip a magic switch to turn on these strategic frictions, which means there is no easy way for Trump to switch them off.

DH5_2155Daniel Wu is a Research Analyst with Montaka Global Investments.
To learn more about Montaka, please call +612 7202 0100.

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Our Montaka Active Extension strategy strives for maximised return over the long-term. Owning the Montaka long portfolio typically scaled up to approximately 130 percent - and the Montaka short portfolio typically scaled down to approximately 30 percent – this strategy results in a net market exposure of approximately 100 percent most of the time.

Our Montaka variable net strategy strives for significant downside protection – but with minimal upside reduction. Focused on owning the world’s great and growing businesses when they are undervalued, while managing a portfolio of short positions in businesses that are deteriorating, misperceived, and overvalued, this strategy is our flagship long-short

Our Montgomery Global strategy strives to act as a core, high conviction, global portfolio holding. Consistent with the long portfolios in our Montaka strategies, this offering is focused on owning the world’s high quality, undervalued businesses – and cash when appropriate – to outperform its benchmark. Branded as “Montgomery Global” in Australia to reflect a key.