• Alarming escalation in the US-China spa: Meng Wanzhou, Huawei’s chief financial officer, was arrested in Canada following a US extradition request for allegedly breaching sanctions on Iran – an unusually provocative course of action given that most firms that run afoul of Iran sanctions have been merely subjected to heavy fines.
• China retaliates: After threatening “serious consequences”, China arrested Michael Kovrig, an ex-Canadian diplomat based in Beijing, and Michael Spavor, a Canadian businessman, on suspicions of engaging in activity which threatened China’s national security.
• Nevertheless, some initial results from US-China trade talks: China has agreed to slash its tariffs on US cars to 15%, down from 40%. In addition, China resumed purchases of US soybeans, which it halted in July in order to target Trump’s voter base in rural US.
• China could delay “Made in China 2025”: According to media reports, China is considering plans to delay some aspects of its ambitious “Made in China 2025” by a decade. Recently, China had also promised deep reforms in the area of science and technology, allow foreign firms greater less fettered access to its economy, and redouble its efforts to protect intellectual property rights. However, a final decision is unlikely to have been reached.
- Anti-China hawks in US are gaining the upper hand…
• US Secretary of State Pompeo said in a speech to NATO in Brussels that Trump seeks a “new liberal order” whereby international agreements will be reformed as he sees fit to stop “bad actors” such as Russia, China and Iran from gaining traction.
• Senator Marco Rubio has announced that he will introduce legislation in the US Senate to ban Huawei from operating in the US.
• US Secretary of State Mike Pompeo launched accusations that China hacked US hoteling chain Marriott, leading to the potential theft of information of up to 500 million individuals, and that it was “conducting espionage and influence operations” in the US.
• US Secretary of Commerce Wilbur Ross has spoken firmly of the need for “verification procedures” and “enforcement mechanisms” should the fundamental structural changes that US seeks in China be attainable.
China may see no alternative than to react more aggressively:
Media reports suggest that Chinese President Xi Jinping had been made aware of the arrest just before he sat down to dinner with President Trump on 1st December but chose not to bring up the issue on the hope that talks with Trump would ease tensions.
Assessment (1): Trade frictions to resume and broaden
First, the unprecedented move by the US to arrest Meng Wanzhou borders on the verge of bullying and places Xi in an impossible situation: he cannot be seen to back down in the face of US intimidation. Indeed, China has retaliated by detaining Canadian individuals, protesting against what it possibly views as the US roping in allies into what was a squabble confined to the two powers. Going forward, US-China trade talks will likely be tinged with an undertone of Chinese anger at its citizens being ensnared in the mess. With seemingly no end to the US onslaught, Xi could conclude that the US is not negotiating in good faith.
Second, while China has made several concessions, they are unlikely to suffice for the US whom, spurred on by anti-China hawks in the Trump administration, is angling for deep structural changes in the Chinese economy. For instance, Trump understands that China’s backtracking on auto tariffs are not a big deal since it does not import much cars from the US; American-brand cars are increasingly bought domestically from US auto firms that have set up production facilities in China. For its part, China has wizened up to interpret aggressive targeting of Huawei by the US and its allies as part of a broader strategy to prevent China’s rise as a technological power, and is considering the extent to which it is prepared to alter its developmental policies. At the same time, there is deep scepticism within the Trump administration that Beijing would be committed to making permanent changes to such policies that has rankled the US business community as heavy subsidies for state firms and intellectual property appropriation by any means. Therefore, the US is unlikely to accept terms which do not explicitly hobble China’s technological ambitions. In short, anti-China hawks in Washington are driving a difficult bargain with China – one that it may not be able to acquiesce to.
Lastly, and most simply, there was always considerable doubt as to whether the trade ceasefire would
ever lead to a substantive deal, as 90 days is too short a time to secure a compromise on highly
contentious issues which have so far eluded negotiators from both sides.
Assessment (2): Asia will be hit in 2019, though production relocation is a silver lining
With renewed tensions, there is now a much higher chance that the US-China trade talks will end in
failure such that the US will proceed with raising tariffs on Chinese goods to 25% on 1st March. That would only be the most visible action among a broader set of trade and investment restrictions against China. This will cast a chill over world trade and – unless there is a massive stimulus package in China – dent Chinese economic growth.
Such a series of events will quickly spill over onto Asia whose fortunes are highly tied to China’s:
exports of components to China would fall, and prices of economically-sensitive commodities such as base metals and rubber could take a hit from slower Chinese growth.
However, we believe that the ongoing diversion of trade and investments from China to the Southeast Asian region will pick up pace, should trade tensions continue to escalate.
The immediate effect will be more production quotas being allocated by customers to manufacturers with existing plants outside China. That will benefit Southeast Asia where many of the competitors to Chinese firms are located.
This will be followed by the outright shifting of production facilities out of China, though to some extent the relocation may be back to developed countries. For example, where production is high-tech in nature or require an advanced supportive eco-system, production may well go back to Japan, Korea and Taiwan. But where the eco-system requirements are less sophisticated, Vietnam will be the big winner, followed by Thailand and Malaysia.