Update on Sino-U.S. Relations

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A strange feature of the aftermath of the 2008-9 financial crisis is that compared with the shrinking of global production, there is no rebound in international finance. Even stranger is that after Donald Trump sought to decouple from China economically, the Biden administration seemed indifferent to global capital.

This caused fund managers in developed countries to dump Chinese bonds and stocks earlier last week-in the face of Beijing’s continued attacks on Chinese technology giants and their China. New attack China’s private education industry-an amazing turning point. Considering the absolute momentum of record-breaking capital inflows into China, double this.

China’s foreign direct investment stock has risen from US$587 billion in 2010 to US$1.9 trillion in 2020. Although global foreign direct investment fell by 35% to US$1 trillion last year, the inflow of funds to China increased from US$141 billion to US$149 billion. There is no doubt that this partly reflects the view on the rapid recovery from Covid-19.

In the first half of this year, foreign investors also purchased US$35 billion in Chinese onshore stocks and US$75 billion in government bonds, each of which was 50% higher than the active level before the outbreak in 2019. In the United States, until this month, investors basically ignored the government’s threats and removed companies that failed to meet stricter audit compliance requirements. The same is true for prohibiting investment in Chinese companies that have links with the military.

Nicholas Lardy of the Peterson Institute for International Economics pointed out that the decoupling of the global economy from China did not happen at all. In fact, “in some key aspects, China’s integration into the global economy is constantly deepening.”

To a certain extent, this reflects Beijing’s leadership’s commitment to gradually opening up the financial system. The best people on Wall Street are fascinated by the prospect of China’s gold at the end of the global rainbow, and they are greatly encouraged by the recent relaxation of ownership rules by Beijing regulators to control the shares of Chinese securities companies and fund management groups.

By relaxing restrictions on the inflow of bonds and stocks, the Chinese authorities have been helping to ease the solvency problems of overly strained US and European pension funds. In the context of the appreciation of the renminbi, these investors found that the yield of the Chinese bond market was higher than that of the United States or Europe.

At the same time, Chinese stocks listed domestically and in the United States provide an opportunity to enter the vibrant technology industry. Research firm Rhodium Consulting estimates that US investors will hold US$1.1 trillion in shares issued by Chinese companies at the end of 2020.

The market turmoil last week showed that investors in developed countries underestimated the Chinese Communist Party’s emphasis on control and social stability. Beijing is committed to reducing the size of the tech giants and strengthening its control over data. Its tilt towards the tutoring market aims to make education less friendly to the elite.

The leadership is also determined to block the attempt by the Accounting Oversight Committee of US Listed Companies to obtain documents from Chinese companies listed in the US.Former diplomat Roger Gasside suggested in his book Chinese coup The US threat to delist Chinese companies that do not comply with the regulations is not groundless. He believes that the tensions surrounding capital market issues may severely escalate.

The scope of China’s retaliation is also real, especially with regard to so-called variable interest entities (VIEs) through which American investors can obtain Chinese stocks. Beijing’s sudden ban on the use of VIE by tutoring companies highlights the risks of this arrangement, which grants only weak ownership and no control over onshore Chinese companies.

If greater hostility towards foreign investment continues, China will pay the price. So far, Beijing’s desire for the renminbi to become a global reserve currency has been well supported by its liberalized financial markets. However, the crucial next step—capital account liberalization—is always a challenge for the party because it leads to loss of control. It will become more difficult if foreign inflows decrease to offset the capital flight released by wealthy Chinese who do not trust the regime.

The United States and China have a common interest in continuing financial interdependence. But like broader geopolitical competition, friction also runs the risk of getting out of control. The global financial alchemy of relatively poor Chinese helping to fund pensions in rich countries is no longer taken for granted.

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