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Viewpoints: Understanding China’s Long Game Fall 2018

While much of the press coverage through 2018 concerning China and the U.S. has centered around trade wars, tariffs, and related issues, something that has been getting much less press coverage is the agenda China has been pursuing for several years now to forge stronger trade ties in an effort to assemble an “eco-system” of economic alliances independent of U.S. involvement. For the first time in its history, China is altering its historical bias of inward focus and turning its attention and economic diplomacy outward, with the intention of establishing trading partners and customers for Chinese-produced goods and services worldwide. All this comes at a time when the U.S. seems to be in the process of altering its own focus from one that has primarily been (since the early part of the 20th century) outwardly focused to one that appears to be more inward and America-centric. Where such divergent strategic paths take these two world powers, and the responses and reactions that result will likely have profound implications for the economic trajectory of each and for the companies that make up their respective economies.

Consider the following facts and events we have observed over the past year:

  1. President Xi Jinping’s self-described “dream” for China is for the country to develop into the world’s preeminent geo-political and geo-economic power. Through expanded trade around the world along a newly established and modernized economic “Silk Road,” China implies it will provide benefits to every country that participates and cooperates as a partner and contributor.
  2. Xi aspires to transform China’s economy from an investment-driven economy (which drove its growth from 1990-2015) to a consumer-based and innovation-centric economy. This includes championing many national brands that will rival the biggest worldwide consumer brands of the West and also Xi’s “Made In China 2025” initiative, whereby China will look to support and strengthen a core group of “national champion” companies. China has expressed hope that with government support and protection, these enterprises will eventually be able to convert their market dominance in China into dominance in all world markets. The focus here will be on higher value-add industries in manufacturing, logistics, banking, technology, biotechnology, aviation, computing, and data.
  3. “New Style” companies in China are cooperating in the country’s unique brand of coordinated capitalism in which the government directs, coordinates, and encourages cooperation between companies and synchronized investment in unique, global eco-systems. If successful, this approach will allow companies in China to compete on a scale that few other global players can match (often because of anti-trust laws). Companies like Alibaba and Tencent are already forging ties with partners in international markets whereby they offer capital, technology, logistics, financing, and payment systems in exchange for being the beneficiary of the customer data that flows from these massive networks. Contrast this to the traditional western corporate model of multiple companies in a given industry, all deploying redundant capital in a competitive race for returns with the ultimate goal being the concentration of top-down vertical power and market dominance.
  4. China’s diplomatic efforts are almost the mirror opposite of those being pursued by the U.S. today. Instead of isolation and withdrawal, China has sought to deploy abundant capital to governments and partners around the world to achieve maximum leverage in future trade relations. This capital centric strategy comes at a time when emerging market players are suffering from weakening currencies (versus the U.S. dollar) and are more open to accepting favorable terms on loans from China in exchange for non- dollar trade commitments in the future.
  5. When the U.S. made a decision in the early days of the Trump administration to pull out of the Trans- Pacific Partnership, the eleven remaining countries made a decision to move forward with the initiative. What resulted was a free-trading accord signed between the 11 remaining countries that excluded the U.S. What is significant here is that all of the partnership’s members count China as their number one trading partner.
  6. In the spring of 2018, the very first trilateral summit took place with China, Japan, and South Korea coming together to discuss the possibility of a free-trading zone between the three countries. Additionally, since the U.S. has made diplomatic progress with North Korea in talks with Kim Jong Un, China has even spoken about including North Korea in this group at some point. All this came about shortly after the U.S. stunned Japan’s Prime Minister Shinzo Abe in the spring with talk of trade tariffs, creating a renewed urgency for Japan to want to improve Japan-China relations. This is the first notable advance of a cordial relationship between Japan and China in 11 years and it included an agreement to jointly coordinate on any military actions in the region going forward.
  7. In the early Summer of 2018, a meeting of the Shanghai Cooperation Organization brought together its regular members (China, Russia, India, Pakistan, Kazakhstan, Kyrgyzstan, Tajikistan, and Uzbekistan) along with 4 invited observer states (Iran, Belarus, Afghanistan, and Mongolia) to discuss coordinated actions and responses on regional security and to coordinate joint military exercises in the Ural mountain region. The member states of this group make up over 40% of the world’s population today.
  8. Today roughly 100 state-owned Chinese enterprises are operating in Africa, and they account for 55% of the total Chinese investment on the continent. Some of the activities that they have engaged in include involvement in a major e-commerce platform known as, which facilitates many business processes including contract signing, logistics, customs, foreign exchange, and payments. The payment engine that allows for settlement between businesses is powered by China’s UnionPay.

Our View: Where is China headed with all this? We think their strategy has evolved in recent years from an inward focus, whereby they were building out their infrastructure, developing their skilled work-force, and protecting their internal markets for the benefit of their government-owned and sponsored national champions to one which is more outwardly focused today. For China to advance its interests and influence worldwide, it needs strong trading partners and alliances. Some of these partnerships can be based on trade while others can result from China’s willingness to help with lending money for, or directly constructing vital infrastructure for these partners. In the end, what China may be aspiring to is a new global financial architecture that gives its trading partners an alternative to the current system today centered around the dollar as the exclusive reserve currency used in trade and from the International Monetary Fund (IMF) and the World Bank as the lenders of last resort for vital infrastructure and development loans.

China’s Asian Infrastructure Bank has openly indicated its objective to become an alternative to the World Bank/IMF system. The carrot that they can offer to participating countries is access and investment into the rapidly growing Chinese economy. The ultimate goal of China appears to be to establish partners who are willing to conduct trade in yuan rather than dollars. It seems likely that they will face a long road ahead to achieve such a goal, but the stakes in doing so are enormous.

More recent actions of the U.S. have caused some unanticipated challenges to this plan, with the trade wars creating a need for China to loosen their monetary policy and weaken their currency, causing collateral damage around the world for the weakest emerging market currencies. However, should China be able to weather this trade storm without too much of a drop-off in its own growth rate, the window of opportunity that has been created by the U.S. taking unilateral actions provides China with an opportunity to portray itself as a “good cop” on the global stage to countries and potential allies looking for a way to escape U.S.-imposed volatility in their own currencies and trade.

Our Conclusion: This is definitely something to watch as trade talks continue unfolding between China and the U.S., especially after the mid-term elections in November.

The Potential Opportunity: Remain vigilant for further weakness in some of the higher-quality companies in China and the broader emerging market space that come under pressure with increased trade tensions.