How Will China Emerge?

Eric P. Leve, CFA, Executive Vice President and Chief Investment Officer

June 30, 2020

It’s not geology, but the Pacific Ocean feels wider than ever. In mid-January, Presidents Donald Trump and Xi Jinping signed phase one of a trade deal that rolled back the tariffs put in place late last year, suspended planned tariff increases, and agreed to increases of purchases of U.S. goods by the Chinese. The equity markets loved the deal and it was the strongest symbol that both sides wanted to resolve the nearly two-year- old trade fracas. At the same time, the World Health Organization had identified a virus in Wuhan, China that had infected several dozen people and was potentially spreading person-to-person. The catalyst of COVID-19 will likely overshadow the trade deal, again widening the rift between China and the United States.

These unprecedented past few months have heightened the polarized relationship between the two countries under Presidents Trump and Xi. In most every arena—from political and economic to financial and technological—both leaders have reason to be suspicious of the other as well as credible means to enhance self-sufficiency.

So, a simple question: does China come out of this crisis hobbled or with a new spring in its step? China’s meteoric economic growth of the past three decades came crashing down with the rest of the global economy, falling 6.8% for the year ended March 31st. China was ground zero for COVID-19. Its economy was hit first but, after some dithering by the government, the eventual response was vigorous and allowed its economy to “reopen” before the rest of the world.

China is renowned for grandiose and costly plans that are often inefficiently or ineptly enacted. Its Belt and Road Initiative (an effort to build infrastructure around the world to increase access to gas, oil, and other raw materials) was a foreign policy centerpiece until many participating countries began to balk at the economic arrangements perceived more as economic colonialism than as aid with bilateral benefits. The country has shifted focus to its “Made in China 2025” plan. This one fits neatly into China’s (and many countries’) desire to shorten supply chains, driven by COVID fears and nationalistic rhetoric to bring jobs home. China outlined the plan’s framework five years ago: invest in the critical technology infrastructure of the future (e.g., 5G, internet of things, ultra-high volt- age power transmission, high speed rail, EV charging stations, and data centers) to transform the country from a follower into a global leader. China plans to spend more than $500 billion this year, only one-third of the $1.5 trillion investment expected by 2025.

The catalyst of COVID-19 will likely overshadow the trade deal, again widening the rift between China and the United States.

Even so, China will likely never achieve its extraordinary growth rates from the past generation. It became one of the world’s lowest-cost exporters and enjoyed increasing domestic demand as more than 400 million people joined its middle class. Both of these historic tailwinds will be more muted moving forward and, un- fortunately, demography is catching up with China. With relatively more people aging out of the workforce than entering it, China is likely to “grow old before it gets rich.”

It comes as no surprise that China is acting out at its neighbors during the COVID downturn, both politically and militarily; if less likely to become a global hegemon, it is increasingly clear that China wants regional dominance. The country has dramatically increased its activity in the South China Sea, an area where Vietnam, the Philippines, Taiwan, Malaysia, and Brunei all face competing claims with China. And, for the first time in decades, China and India had a deadly clash over a disputed border during the quarter.

And perhaps most critically, the “one country, two systems” policy with Hong Kong rings increasingly hollow. A new national security law passed in late June (notably in Beijing and therefore bypassing Hong Kong’s legislature) would essentially put the Hong Kong judiciary under control of the island state’s executive branch, an area already under de facto Mainland control.

The lone positive in U.S.-China relations comes with a big caveat. While U.S. authorities reinstated American companies’ ability to work with Chinese tech giant Huawei, the rationale was only because of Huawei’s 5G network technology dominance and a desire to avoid getting left behind. Other than that, the two superpowers spent the last few months shooting across their respective bows, volleying blame and sharp critiques related to the COVID crisis. Further evidencing the state of affairs: the U.S. moved to cancel visas for some Chinese graduate students in the U.S., the Senate passed a bill to delist Chinese companies on U.S. stock exchanges that don’t meet audit standards, and both nations expelled a number of the other’s journalists.

China’s quick economic rebound from its early pandemic-related contraction will lead to full-year results that will be the envy of the world. Still, its economic activity is a far cry from the nation’s historical standards as annual economic growth below 6% is expected to become more the rule than exception. China will be a formidable technological and economic rival, and the nation’s rise will lead to continued efforts to expand its political influence over the Western Pacific. But, we believe China’s poor demographics and inefficient economic policies will likely keep it far from the U.S. horizon over the long run.