Partnerships, Competition, and Conflict – Moneyweb
The first formal agreement between the United States and China was forged in 1844 under questionable circumstances. After Britain secured significant concessions from the Qing Empire during the First Opium War, the United States sought to obtain similar favorable terms.
This led to the signing of the Treaty of Wangxia, establishing a relationship between a rising power, the US, and a declining one.
The treaty granted the US access to five treaty ports (Guangzhou, Xiamen, Fuzhou, Ningbo, and Shanghai), where Westerners enjoyed special privileges such as extraterritoriality. This particularly incensed the Chinese, as it meant that Westerners accused of crimes could avoid trial by Chinese courts.
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This event marked the onset of what is referred to in China as the “century of humiliation,” characterized by a second Opium War, a Japanese invasion, civil war, and the communist revolution in 1949.
In stark contrast, last week’s meeting between Presidents Donald Trump and Xi Jinping in Beijing unfolded in a much more amicable setting, leading to expressions of friendship and cooperation.
However, significant underlying tensions remain.
At present, China is re-emerging as a challenger to the US’s status as the world’s sole superpower. China has forged strong alliances with Russia and opposes Western support for Ukraine while being a major customer of Iran.
Taiwan continues to be a major point of conflict, with China pushing for eventual reunification while the US supports the current status.
Taiwan’s pivotal role as the leading producer of advanced semiconductors places it at the forefront of the artificial intelligence (AI) boom, adding further complexity to the situation.
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The US is making efforts to maintain its edge in AI and other technologies by restricting China’s access to high-end chips. Conversely, China is excelling in green technology, being the highest producer of solar panels, batteries, wind turbines, and electric vehicles.
Essentially, it serves as the Saudi Arabia of clean energy, and given that AI is highly energy-intensive, this could ultimately provide it with a competitive advantage.
China also commands 80% to 90% of the global supply of several “rare earth” minerals, crucial for various military and industrial technologies, giving it substantial leverage in negotiations with any nation, including the US.
The world’s factory
China is indeed the leading producer of numerous essential goods for global markets, encompassing both basic and advanced technologies. Consequently, its trade surplus (exports minus imports) has skyrocketed, surpassing $1 trillion last year.
This narrative recalls historical events.
The Opium Wars forced China into accepting drug imports from Britain and other colonial forces.
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While the Western world craved Chinese products, this desire wasn’t reciprocated, resulting in considerable gold and silver flowing eastward [China accepted payments solely in precious metals]. Forcing China to import opium at gunpoint—impacting its population’s well-being—had dire social consequences and was a strategy to redress the severe trade imbalance.
Similarly, Trump imposed tariffs on China during his first term to tackle the modern trade deficit, and his successor, Joe Biden, largely upheld these measures.
Hardline positions on China have become a rare bipartisan concern in Washington.
During his second term, Trump ramped up these efforts, at one point imposing tariffs on Chinese imports as high as 145%. After negotiations, exemptions, and ultimately the involvement of the Supreme Court, the actual tariff on Chinese goods stands at about 25%, still significantly higher than before.
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As a consequence, exports from China to the US have markedly dropped. At its peak in 2017, nearly a quarter of US imports by value came from China.
By April of this year, that figure had plummeted to a mere 8%, although a substantial amount may still be rerouted through third nations like Vietnam.
While much of the globe has not joined Trump in raising trade barriers against China, it doesn’t imply they lack desire to do so.
China’s exports and imports by value
Source: LSEG Datastream
This impressive export performance, juxtaposed with the relative fall in imports, suggests a shift toward domestic brands.
However, the trade surplus also highlights a weakness: a lack of domestic consumption. This is partly a conscious decision.
As is commonly recognized, China’s economic model inherently favors investment over consumption, resulting in households having a smaller share of national income compared to countries at a similar developmental stage.
At the same time, considerable resources have been allocated to developing top-tier infrastructure and manufacturing capabilities. Yet, a substantial portion of this investment has been directed toward residential real estate, leading to a massive bubble that burst in 2022.
The repercussions of the property bubble continue to send shockwaves through the economy. A decline in apartment sales translates to fewer purchases of appliances like fridges, televisions, and beds, a significant portion of which would have been imported.
If imports matched exports, Chinese consumers could have purchased an additional $100 to $200 billion of foreign goods.
In contrast, consumer confidence remains at historically low levels, although it has seen slight improvement compared to a year ago.
Chinese consumer confidence
Source: LSEG Datastream
Yuan too few
Another key factor behind the weak imports—and robust exports—is the undervalued currency, a long-standing complaint from the US government.
Typically, a nation with such a substantial trade surplus would experience upward pressure on its currency. Even after some recent gains, the yuan remains relatively weak on a real trade-weighted basis.
China real trade-weighted exchange rate
Source: OECD
A depreciated currency usually boosts exports and limits imports, which is why Trump calls for a weaker dollar and a stronger yuan.
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A shift in this direction would help balance the trade relationship between China and the global community while improving the purchasing capacity of Chinese households, enabling access to more foreign goods, services, and opportunities for international travel.
The yuan’s exchange rate is managed by the People’s Bank of China (PBOC), rendering its level a deliberate choice rather than an inevitability.
While a gradual appreciation of the yuan makes sense in the long run, the PBOC generally prioritizes stability over other factors.
This brings us to a final comparison between US and Chinese equity markets. Despite China positioning itself as an economic, military, and technological powerhouse, market valuations tell a different story.
In contrast, despite discussions about a US decline during Trump’s erratic tenure, the S&P 500 has consistently achieved new record highs, even amid ongoing geopolitical tensions.
Forward price-earnings ratios
Source: LSEG Datastream
Chinese equities are currently trading at a notable discount compared to US counterparts, particularly considering that the yield on a 10-year US government bond was just below 4.5% last week, while China’s equivalent stood at only 1.7%. This indicates a significant ‘equity risk premium’ in Chinese stocks, while US equities exhibit minimal margin of safety.
Some of this gap can be attributed to erratic regulatory changes that led to China being deemed “uninvestable” around 2021. However, since then, authorities have adjusted their position regarding Chinese equity markets.
Historically, Beijing has considered equity markets as secondary, prioritizing speculation less than economic funding via the banking system. But banks are now constrained by a faltering property sector, and the successes of other countries—particularly in the US tech sector—have illustrated how equity markets can facilitate innovation and business growth while also generating wealth for households, which is crucial for a nation with an aging population and uneven social security systems.
Thus, regulators aim to nurture a “slow bull market” with steadily rising equity values that can help stimulate economic growth and assist Chinese families in saving for retirement.
To achieve this, corporate governance standards have been enhanced, and publicly traded companies are being encouraged to provide regular dividends, representing a much-needed pivot toward a more shareholder-friendly landscape.
Despite China’s remarkable economic strides, publicly listed companies have struggled to convert GDP growth into profit growth, resulting in lackluster equity returns. In contrast, the primary reason behind the premium on the S&P 500 likely stems from its consistent growth in earnings per share, surpassing other major markets.
The profitability of China’s industrial firms has been further impeded by overcapacity and fierce competition, challenges policymakers are attempting to tackle through “anti-involution” tactics.
For equity investors beyond China’s borders, the blend of a devalued currency, attractive valuations, and increasing policy support is likely to be appealing.
China’s share in the predominant global equity indexes compiled by entities like MSCI and FTSE Russell has dipped to about 3%, which is disproportionate to its contribution to global economic output and innovation.
Nonetheless, risks remain.
China’s challenging demographic circumstances are widely acknowledged, resulting largely from the now-defunct one-child policy. Last year saw just 7.9 million newborns, the lowest figure since the Communist Party assumed power in 1949.
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While life expectancy has markedly risen—currently surpassing that of the US, which is a notable achievement—this does little to alleviate workforce shrinkage and will inevitably limit long-term GDP growth rates (from an equity investor’s perspective, profits carry more weight than GDP).
This trend may also encourage innovation and technological adoption.
According to the International Federation of Robotics, China accounted for half of the world’s industrial robot installations in 2024, primarily supplied by domestic producers for the first time.
China’s approach to artificial intelligence seems to focus on practical applications rather than the pursuit of leading-edge models, setting it apart from Silicon Valley’s winner-takes-all mentality.
Time will determine the effectiveness of either strategy.
Total debt-to-GDP ratios
Source: Bank for International Settlements
A significant concern arises from the elevated total (comprising household, government, corporate, and financial sector) debt levels, which surpass those of the US when expressed as a percentage of GDP. Moreover, the rapidity with which this debt has grown is clearly unsustainable.
China boasts a far higher savings rate than the US or any other large economy, with most of the debt being internal.
Thus, the issue primarily pertains to internal distribution rather than existential threats. However, in a slowing economy, servicing this debt becomes increasingly difficult, with losses ultimately falling on someone’s shoulders.
A notable risk lies in the US-China relationship.
Both nations are actively seeking to mitigate their reliance on one another, with China possibly holding the upper hand. Nonetheless, the economies remain deeply interwoven, making the idea of complete decoupling unrealistic.
Consequently, a sharp rupture over Taiwan or other flashpoints could result in a substantial market sell-off, affecting markets worldwide, not just in China.
If the US were to impose sanctions on China, financial institutions would need to comply or risk isolation from the dollar system.
The US retains substantial leverage in this context, which China is acutely aware of.
This kind of conflict would be harmful for all parties involved, emphasizing the importance of last week’s summit between Trump and Xi, even if it did not produce groundbreaking policy shifts or resolutions on complex issues.
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While cordial gestures may not resolve deep-seated disputes, they ensure that lines of communication remain in place. The strategic rivalry between the world’s superpowers is unavoidable, yet it can be successfully managed.
Ultimately, both parties—and the entire globe—stand to suffer should this rivalry escalate into outright conflict.
Izak Odendaal is an investment strategist at Old Mutual Wealth.