Listen: Tensions have been building between the US and China for some time, and the Biden administration and President Xi's leadership team have not found much new common ground. We'll look at how Xi Jinping's latest actions to focus on "Common Prosperity" have changed China's priorities, what the crackdown on certain industries means for markets, and how the U.S. is responding to these policy shifts for better or for worse.
The latest episode of Living Beyond Borders, a special podcast series from GZERO and Citi Private Bank, is the first in a two-part series on the relationship between the US and China. Moderated by Caitlin Dean, Head of the Geostrategy Practice at Eurasia Group, this episode features David Bailin, Chief Investment Officer and Global Head of Investments for Citi Global Wealth, Steven Lo, Co-Head of Citi Global Wealth for Asia Pacific, and Ian Bremmer, President at Eurasia Group and GZERO Media.
David Bailin
Chief Investment Officer and Global Head of Investments, Citi Global Wealth
Steven Lo
Co-head of Citi Global Wealth, Asia Pacific
Ian Bremmer
President, Eurasia Group and GZERO Media
Caitlin Dean
Practice Head, Geostrategy, Eurasia Group
Transcript: Season 3, Epsode : 5 Tariffs, Tutors, and Tension: The US and China (Part I)
Disclosure: The opinions expressed by Eurasia Group analysts in this podcast episode are their own, and may differ from those of Citigroup Inc and its affiliates.
Caitlin Dean: Welcome to Living Beyond Borders, the podcast from Citi Private Bank and GZERO Media that examines the risks and opportunities in a rapidly changing world. From global politics to economics and what it all means for you. I'm Caitlin Dean, head of the Geostrategy practice at Eurasia Group.
For decades, two city states lived in relative peace. Sparta was known far and wide as the most powerful entity in Greece, unmatched in its military might and prosperity. That is until Sparta's neighbor to the north, Athens, began to amass wealth and power as well. In his history of the Peloponnesian war, the ancient historian Thucydides put it this way. It was the rise of Athens and the fear that this instilled in Sparta that made war inevitable. That idea that war is inevitable when one group starts to challenge the dominant power became the basis of a 21st century theory called the Thucydides Trap.
And while not everyone has agreed with Graham Allison's theory, the idea has made a lasting impression on those looking for a framework for the modern relationship between China and the United States. This rivalry is always shifting. And the latest shifts come as a result of new leadership in the United States and new policy decisions in China. These latest developments are likely to have lasting impacts on the global economy and geopolitical balance. And so we wanted to talk about both the current and future relationship in this special two-part series of Living Beyond Borders.
Let's dive in now to discuss the current dynamics between China and the U.S. with three top experts. Steven Lo, co-head of Citi Global Wealth for Asia Pacific.
David Bailin, chief investment officer and global head of investments for Citi Global Wealth. And Ian Bremmer, president at Eurasia Group and GZERO Media. Welcome to all three of you.
Steven Lo: Thank you.
David Bailin: Thank you, Caitlin.
Ian Bremmer: Great to be with you.
Caitlin Dean: Now we've talked about the US-China relationship on this show before, but things change fast between the two countries. Steven, what are some of the biggest economic points of tension between the U.S. and China that you've got your eye on right now?
Steven Lo: I would like to answer that from two perspectives. From a Chinese perspective, the biggest economic points of tension are still with the U.S. tariffs imposed on Chinese exports. In the past, these have averaged about three to 4%. Now these are averaging over 19. Other tension relate to the barriers put up on people to people, cultural and scientific exchanges between China and the U.S.
These Trump era policies, though being revealed by Biden administration, are mostly still in place. The markets are not optimistic that these policies could be removed or adjusted soon. Indeed the Chinese side is losing patience, and has reacted by tabling two lists of action to the U.S. side when deputy secretary state, Wendy Sherman, visited Tianjin in July. One is on U.S. wrongdoings that must stop. And the other on the key individual cases that China has concerns about.
From the U.S. perspective, China has exerted more control over its economy after the 1st of July. This marked at the Centennial celebration of the Chinese Communist Party this year. The Chinese authorities have since issued in a number of policies, ranging from investigating Didi for its data security breach; cracking down on the after school tutoring sectors; restricting the number of hours teenagers can play online games - which personally I'm totally in favor of. And levying fines on e-commerce platform companies as part of its anti-monopoly campaign.
This policy have led to a large sell off of Chinese concept stocks in Nasdaq, and the Hong Kong Stock Exchange, creating large valuation losses. The SCC has reacted by halting the IPOs of a Chinese listing in the U.S. In addition, China has asserted further political control on Hong Kong with the implementation of an election law this year. The law basically requires that the candidates allowed to run are deemed more patriotic to China. This together with the national security law has led to more control over Hong Kong.
Although this control have not affected foreign businesses operating in Hong Kong, concerns remain as to whether these political controls over Hong Kong will eventually affect Hong Kong's busy climate. A good thing is that the U.S. and China moving forward to address these tensions, a virtual summit between Biden and Xi has been planned later this year. And economic and financial official from both sides are talking to each other. Removing some of the tariffs could be good to both sides as the pace of China's economy is slowing more evidently, and the U.S. is facing higher consumer inflation.
Caitlin Dean: And Ian, after the passage of the presidential seal from President Trump to President Biden, many people expected a closer relationship between the U.S. and China. What has happened and where do you see the relationship improving or worsening between the superpowers?
Ian Bremmer: Oh, it's not getting better. I don't think there's any component of the US-China relationship that you could say right now is improving. Whether you look at trade relations, technology relations, national security concerns like the South China Sea, or Taiwan, and even the nuclear balance, frankly, which has not been much of an issue with China, but is starting to become one. And domestic and human rights issues like with the Uyghurs for example, or Tibet.
On pretty much every single one of those issues, there is a complete absence of trust between the United States and China, and that's mutual. And also there's not a lot of near term effort to do anything to try to improve it. The one area that I think the United States was hopeful that there would be a level of cooperation is on climate. And the Chinese government has repeatedly made clear that as long as the extent relationship between the two countries is what I just described, there will be no warmth.
Having said that, I would say that the U.S. China relationship feels a little bit more stable, a little bit less uncertain, a little bit less volatile today than it did three or six months ago. You'll remember that the first meeting between the Biden team and the Chinese foreign policy team in Anchorage was a disaster. It was by far the worst meeting in foreign policy, the Biden administration has had with any country to date.
There has been significant efforts to calm the temperature on the direct bilateral relations between the two countries that I think have been successful, both in Zurich, when Jake Sullivan met with his counterpart a few weeks ago from Beijing. When Biden said at the UN General Assembly meeting that the U.S. is not in a cold war with China. And the Chinese have viewed that as constructive and appreciate it. And I think that it does mean that both sides want to at least avoid the potential for a precipitant crisis between the two countries. They'd like to ensure that relations don't get much worse all of a sudden on any of these issues.
Caitlin Dean: Okay. So maybe not substantively better, but at least there's a floor under which we hope it won't go any lower.
Ian Bremmer: I think that's right. I think that's what both administrations are trying to signal to each other right now. And I think you're going to see more engagement between both sides as a consequence, especially at a time of pandemic where the Chinese aren't traveling outside their country at all, that's a useful thing.
Caitlin Dean: And what's your assessment of how the two countries are positioning themselves internationally?
Ian Bremmer: I think that the United States wants to be seen as committed strongly to its allies in Asia, who are much more concerned about the rise of China than they are about uncertainty from Washington, whether it's under Trump or under Biden. And by far the most important piece of leadership we've seen from Biden internationally so far has been the vaccine agreement, where the U.S. provides J&J vaccines, the Japanese provide financing, the Australians provide logistics and the Indians provide manufacturing capability. That is all directed at Asia. It is all in response to Chinese vaccine nationalism that hasn't worked so well. And it's generally welcomed by American allies in the region and will probably get us to several hundred million vaccine doses donated a month by the end of the year. So in very short order, and that's an area that the US has underperformed on recently.
So I mean, to the extent that the Americans are doing more in terms of leadership, it's overwhelmingly about Asia, but I think it's important to recognize that the most important multilateral trade deal in the today, CPTPP, does not include the United States and the Chinese have said they want to join, but it doesn't include China either. And that's the interesting point here. The Americans are trying to commit to a greater degree, but really under the Biden Administration globally, you see a lot of countries that are saying we're just not as committed that American leadership is going to be consistent and there for the long haul.
A lot of countries are saying the same thing about China. China's focus is increasingly domestic. It is about common prosperity, which is a top priority for Xi Jinping. He's been talking about it a lot in recent weeks, which really focuses on not allowing either external or internal actors to take advantage of equality of opportunity of the average Chinese to achieve the China dream.
And that means that China's leadership internationally is also lacking quite a bit. And their investment in Belt and Road is down substantially from what it was five years ago, eight years ago. They made this big announcement. They're not going to export investment into coal anymore in advance of the COP 26 summit. Well, they weren't spending any money outside the country on coal in 2020, but they are a greater coal investor domestically than the rest of the world combined. And that domestic focus, I think both for the Chinese and the United States is really the most significant development when we talk about what's happening in Asia and in the world more generally.
Caitlin Dean: David, let's dig a little deeper into how the tension between the countries and China's regulatory changes and policy changes are affecting markets and foreign investment into China. How will it impact China's economic growth and its competitiveness and its exports?
David Bailin: Well, Ian's laid out exactly what I think are the key elements of what's different now, which is that China is focused on its internal politics and its internal economics and this concept of common prosperity. And you can see that in a variety of ways, but the most obvious ones I think have to do with the idea of not focusing on the creation of billionaires and centa-millionaires, but actually focusing on the access to wealth for the average person in China.
We wrote about six weeks ago about the idea that if China is going to continue to grow, it needs to bring another 150 million or 200 million people into its middle class. That is the future engine of growth for China. And to do so, Xi Jinping has actually taken steps that I think are very, very harsh when looked at from a Western perspective, but consistent with that objective.
And let's talk a little bit about what those are. First of all, in the chapter of this real estate subject, which began with evergreen, but is much deeper than that. What's really going on is to clamp down on speculation, the purchase of second and third homes as investment property for the upper middle class and wealthy in China and the creation of billionaires as a result through the ownership of those development companies all financed by Chinese banks. And now to say, wait a minute, we want to make sure that these housing units are available to more Chinese, right? To more middle class people moving and urbanizing. The near term impact of that is terrible, right? From a Western perspective, we're seeing in a huge clamp down on new development, which hurts Chinese economy over the next two to three years.
what it does do is it creates an equilibrium between supply and demand and in doing that actually a stabilization of the real estate market and the removal of speculation from that market. And similarly, what we don't understand in the west, but what's going on in China is that by clamping down on technology companies and specifically on unbridled growth, and I'll give you a specific example of this. What you actually have is that the corner store in China can be maintained. And that is important also for common prosperity, which is to say that the displacement of all retail, the displacement of all businesses in China rapidly by technology, which could have occurred at a very rapid clip, even more so than in the United States is something that Xi Jinping wants to actually slow down, to allow a more orderly transformation within that economy. And so that I think speaks to the clamp down in general on all technology companies, especially those that are consumer facing.
So there is pretty great consistency in the policies from our point of view that are being done in China for the reasons that they are. And they're very different than Western policies than what we'd expect to see. Now you asked a little bit about the impact of all of this, right? Well, the impact on markets is terrible. That is to say, if you're an investor in stocks and someone comes in and delays your ability to grow and slows your earnings growth rate, changes the way that you invest capital, your stock price would go down. And that's exactly what has happened in China. What's interesting, if you look at the market, is that their internal market, that's the Asia market has actually done much better than the foreign markets.
And that reflects the concern of external investors, right? Foreign investors, that what they've done is they've delayed and change the earnings profile of their companies. Whereas domestic investors probably are not as aware of that and therefore are much more sanguine about it. What all of this does though, is it changes the dynamic of how Western companies will consider investing in China. It is far less attractive to invest in China, to take foreign money and move it into China under these circumstances. And the last thing I just wanted to touch upon is that all of this is going to substantially slow China's growth over the next six to 12 months, potentially to as low as 4% growth from what would've been considered a low rate of growth at 7%, just two years ago. So Xi Jinping seems to be willing to take substantial economic pain terms of Chinese growth in order to actually implement these strategies that are pretty radical.
Caitlin Dean: Ian, some of China's policies are having unintended consequences. China's stock market is suffering and it's put constraints on major industries like technology and real estate. So what does all of this mean for Xi's future as leader?
Ian Bremmer: Well, first of all, it's not a democracy. And the consolidation of power in China is not absolute, but it's very significant. It's much greater today than it was five years ago, 10 years ago. It's more similar to Putin's control in the Kremlin than it was. I think that most of the concerns that David has raised, which do create bigger uncertainties around foreign investors into China, does create more downward pressure on China's markets per market performance. But really, most of it has been in service of the average Chinese citizen. I mean, to give you an example, the decision of the Chinese government to say that if you're under 18, you're playing three hours of video games maximum a week, that's it. And if you don't use those hours, you lose them. They don't roll over that. That was an enormous shot against a massive industry inside China and the consumer sector and the children consumer sector for video games is the largest in the world today.
And yet, the Chinese government overnight said, sorry, it's gone. Now, is that in service of Xi's reelection? I would say it is. I would say these are parents that are worried. I think when they shut down the ability of tutors to charge relatively high priced educational courses, training courses that allow wealthy parents to ensure their kids get ahead. The opposite of the varsity blues scandal in the United States. That's a classic populist measure that is targeted squarely at the average Chinese parent saying, we're not going to let wealthy Chinese have huge advantages over your ability to get your kids in school. If they're smart, they're going to have a shot. So a lot of what Xi Jinping is doing, much as the global markets are concerned about it. I think he feels like it's very squarely aligned with the average Chinese... I can't say voter because they don't vote, but the average Chinese citizen, which they care immensely about.
Just because it's authoritarian doesn't mean that there isn't a feedback loop from the average Chinese citizen. You know that when there's an earthquake, when there's a flood, when there's an explosion in a chemical plant, the Chinese leadership shows up very quickly and wants to be seen as cracking heads. Who was involved? Who's responsible? Where was the corruption? Where was the mistake? Those people should go to jail forever. Those people should go to jail forever. Those people should lose their party membership. And meanwhile, the top leadership of China should be seen as trying to work their best for the average citizen in China. Now, that's increasingly hard to do when the level of wealth at the top has become as great as it has. The inequality in China of realities in terms of economic distribution is greater today than it was 10 years ago, it's greater today than it is most of the west, but still that's the message that they're trying to deliver. The one caveat I would give you is we do not have the same level of insight into policymaking decisions in China as we do in any Western democracy. And Xi Jinping is increasingly surrounding himself with a group of people that agree with him and frequently in authoritarian states, that means that bad news is not delivered effectively.
This is not a place where everyone is telling Xi you're screwed up if you're screwed up. I mean, that's just not a recipe to winning. That's of course how they messed up at the beginning in terms of what we know about the pandemic's origins. You had a lot of people that were very scared to deliver bad news in an honest fashion all the way up the chain in Beijing. And as a consequence, there was a coverup which has had massive damage not only for the Chinese consumer but now experiencing that all over the world.
Caitlin Dean: And what about President Xi's more assertive tone on Taiwan. How has that played domestically and how has the US responded?
Ian Bremmer: I'm not sure that's the right frame for the question. I mean, if you look at what Xi Jinping has actually said on Taiwan, the statements aren't that different from what he was saying five years ago. I do think that the Chinese have ramped up their overflights into the air defense identification zone, record numbers right now. And I do think the Chinese state media has made much sharper propaganda against the United States specifically in terms of US actions on Taiwan and also warning the Taiwanese that the Americans wouldn't defend them if it came to a fight, but I could easily make the argument that the United States has done more to change the status quo on Taiwan in terms of Biden's perhaps unintended statements but nonetheless made that the United States would directly come to defend Taiwan, which is not aligned with the strategic ambiguity policy between the two countries and the White House has had to walk back on two separate occasions now.
The fact that the United States is increasing its own Freedom of Navigation Operations, FONOPs, with allies in the Pacific and around Taiwan, that there have been calls, from top US officials that Taiwan should play a more significant role across all of the United Nations organizations as well as the AUKUS and the QUAD Agreements, even though they never mentioned China, but they're all oriented at China and they're oriented around Taiwan. So again, if you were to ask this question from a Beijing perspective, or even the perspective of a third party that was disinterested, I think it would feel differently than just talking about Xi Jinping's assertive tone.
David Bailin: I think we have to extend the meaning of this though a little bit further, because Taiwan is the manufacturer of 50% of the world's semiconductors and it is also the sole center in the world for the development of the most advanced semiconductors. There's an enormous backlog for semiconductors globally and that backlog is only going to get worse as the demand for them increases geometrically over the course of the next decade or two. And that Taiwan is the flashpoint is of great significance to the global economy and the perception that there could be a takeover, military takeover of Taiwan, or even an intervention that would be significant I think is a major top 10 and probably top five wary of anyone who's an investor around the world, or frankly anyone manufacturing anything.
And the other point is that as the two countries bifurcate and the Chinese do not have as much access to the intellectual capital that they need in order to develop new semiconductors, they'll find themselves increasingly behind in their ability to manufacture the most advanced technology. And therefore Taiwan will, in my view, become a more attractive takeover target over the next five years than it even is now because as there's less foreign investment in China, less development of product in China, less R&D by Western firms in China, then the Chinese are going to have to either develop these technologies themselves or actually seek to get them in other ways. It's not going to be possible for them to just buy them. That's one of the big changes that occurred after President Trump was in office. So I think Taiwan is a flashpoint, actually has more potency now than it has had ever in terms of its importance and the reason why it might be a flashpoint because of China's greater needs for technology and for semiconductors in particular.
Ian Bremmer: David, I agree with that completely. Taiwan is becoming more important to both countries and the semiconductor piece is absolutely critical. Here yet again I would say the United States perhaps is doing at least as much to change the status quo. And the point is that we have to get from strategic ambiguity over conventional weapons and diplomacy into an entirely new space. And we're doing it completely absent trust and dialogue between Beijing and Washington on these issues. So it is going to get more dangerous before the next round of parody exists over this issue.
Caitlin Dean: And Stephen, who do you see as the possible winners and losers coming out of these interventions?
Steven Lo: Sure, Caitlin. While the recent policy actions may have good social economic intentions, certain policies may have gone overboard. For example, making more after school tutoring forms nonprofit has made those already listed company non-viable. These companies and investors who had put money in them will lose out. In addition, the lack of communication with the markets and the industry alike has led to large market volatilities and excessive sell offs of the China concept stocks. Because of losses suffered, foreign institution investor are now hesitant in investing in China. In the medium term, there could be also winners coming out of these interventions. Restraining expansion with capital could be beneficial to small and medium sized tech companies. It will allow them to compete against the deeper pockets of the bigger Chinese tech companies by slowing their pace.
Future unicorns could continue to emerge from these small and medium tech companies. Setting a high bar for firms to satisfy data security scrutiny in the US will make them more likely to list in Hong Kong, making the Hong Kong exchange a big winner. Indeed, listing in Asia is something China supports. It would also further enhance Hong Kong's position as a key financial center. The resolve to addressing difficult income equality will lead to wage increases and more provision of public goods. As a result, both foreign and Chinese firms serving domestic consumers could emerge as winners in the future.
China's de-carbonization policy will help support the adoption of electric vehicles and new energy sectors. Firms with leading core technologies, established market positions, and good management could emerge as a potential weakness as well. We do think as long as China continues to open these financial markets for foreign participation, foreign financial institutions could still be long-term winners. They would benefit from China's high saving ratio, huge need for sophisticated financial products, and the growing affluent population. Examples of China willingness to open are the establishment of the GBA, which is the Greater Bay Area, and the Wealth Connect.
Caitlin Dean: So David, Chinese firms will now have to start adhering to stricter standards in the US. This comes after the SEC announced in the summer that they would put a pause on Chinese companies raising money through IPOs in the states without adhering to more guidelines around risk disclosure. So this currently applies to a few hundred Chinese companies and over a hundred in Hong Kong. They have three years to comply, but do we expect that they will?
David Bailin: Well, it's not necessarily how likely it is. It's the cost and consequence of it. And of course, in the world that Ian has painted, the greater the tensions between countries, the greater the possibility that there will be a mistake or something that actually translates into an action that was potentially unintended.
But when you take a look at what Ian talked about of the increased amount of flyovers, we don't all think about what the consequences of that are, but every time the Chinese move into Taiwan's airspace, Taiwan has to respond with flights and the use of its own aircraft to go through a normal routine process. And the use of those aircraft are going to cause them to age. And as they age, they're going to need to be replaced. And their source of replacement is the United States. And I believe that this is also a flash point that it was going to come up sooner than later, because as the military equipment, which is older equipment in Taiwan needs to be replaced and the US steps up to do so, and it will have lots of pressure, lots of desire actually on the part of the West to do that, there's going to be a near term flash point in that replacement. We haven't seen, for example, the deployment of missile defenses significant and highly capable missile defenses in Taiwan, which could also take place at that time.
And so I think that this is a deliberate provocation on the part of China and one that will have further political ramifications as that issue comes up. But these are the things that are not apparent to the average investor, but to us, they represent very significant risks. And it's one of the reasons why five years from now, we're going to see a lot more onshoring of a lot of different technologies in the West and a major, major thrust to investment in the West and a whole range of different things just to avoid this exact circumstances, dependencies on countries that are immediately adjacent to China and therefore, potentially cratering a global supply chain that the world absolutely has to happen.
Caitlin Dean: Ian, let's talk about trade now. It was obviously a major flash point in the Trump administration and it's an ongoing one now in the Biden administration. So what's the current state of play on US-China trade and on tariffs? And how is China faring with the supply chain under strain and with the slowdown in global growth?
Ian Bremmer: The state of play on US-China trade is that President Biden understands enormous political pressure not to be seen as soft on China, even though he does not believe that a policy of high tariffs between the two largest economies of the world is constructive for the United States. And as a consequence, he has maintained the tariff levels that were increased along with negotiations around the phase one China trade deal, which the Chinese have not been in compliance on. And that was said by Trump. And it is now being said by the Biden administration as well, as well as a recent statement of speech by Katherine Tai, the US Trade Representative. They are implementing a larger number of exemptions that can be implied for to get around those tariffs for companies that have important reasons domestically aligned with national security to do so.
And the level of lobbying that goes on in the United States from special interests to ensure that they can apply for those exemptions is the single thing that the Secretary of Commerce has made her top in her engagement, in her department's engagement in the US-China relationship so far. But what that means is that the ability to significantly reduce tariffs from their present levels on the part of the United States is virtually zero in the foreseeable future. So you should be, everybody that's investing should be thinking of that as their baseline going forward. There's not pressure to increase them, but there's a lot of resistance to be able to take them off, especially because you've got midterm elections coming up right now, Biden's approval ratings are roughly around 40, that's the lowest they've been for any president with the exception of Trump in modern history. And as a consequence, they're probably going to lose one or both houses. They need to do everything they can to maintain their domestic political bonafides. And that includes being seen as comparatively tough on China.
In terms of the Chinese supply chain, I would say the supply chain is okay right now, but there are much bigger uncertainties for shutdowns simply because there is zero tolerance for COVID spread. And the Chinese vaccines, they're starting to import Pfizer, which is good. They're doing that under the radar. You don't see it in the Chinese media, but they are doing it. But the Chinese vaccines that are, of course, the largest percentage of vaccines that have been actually jabs in arms that have been given around the world. I mean, this is where the numbers are, but they don't work very well, particularly against Delta.
And so when you combine zero tolerance for spread and vaccines that don't work very well, what you get are lockdowns that suddenly can happen in large provinces, even when there are only a few cases. And that can and will continue to lead to rolling shortages in supply chain. And we've been experiencing that. We're going to continue to experience that. I mean, the interesting thing is you remember a year ago now, China was by far the first country that was able to get its supply chain back up and running because they took these draconian measures. And that was great when you had a much lower variant spread, but in this environment, it's almost impossible for a country the size of China to have COVID under control. And that means economic challenges all across the board.
Caitlin Dean: We'll return next time with more from Steven Lo, Co-Head of Citi Global Wealth for Asia Pacific. David Bailin, Chief Investment Officer and Global Head of Investments at Citi Global Wealth. And Ian Bremmer, President at Eurasia Group and GZERO Media.
That's it for this episode of Living Beyond Borders. Next time, we'll continue our deep dive on the relationship between the US and China moving from where we are now to where each power goes in the future. I'm Caitlin Dean. Thanks for listening.