What started as a trade tensions between the US and China spirals could yet grow into a full-on economic conflict. And were that to occur, asset owners risk becoming a key weapon for each side.
Rumblings of a desire to escalate the trade war into finance have been coming from political figures aligned with president Donald Trump. Steve Bannon, a disheveled white nationalist who is the former strategist of Trump, has clamoured for US bourses to bar Chinese companies from listing and for institutional investors to sell out of them, arguing that they have opaque shareholding structures and may be arms of the Chinese state.
In addition, a bipartisan group of US senators including Republican Marco Rubio sent Trump’s administration a letter in April, urging it to increase the disclosure requirements for US-listed Chinese firms that pose potential security risks or have links to human rights abuses.
"Americans would likely be very troubled, if not outraged, to learn that their retirement and other investment dollars are funding Chinese companies with links to the Chinese government's security apparatus and malevolent behaviour," the letter read.
Effectively these politicians argue that the US should be willing to turn off the financial spigot for Chinese companies as part of its effort to curtail Beijing’s unfair trading practices and prevent companies from the country from prospering to the cost of international rivals. There are also national security concerns, which lay behind the US’s recent decision to ban its companies from selling goods or services to Chinese telecom company Huawei.
These issues are coming to a head for several reasons. The obvious one is Trump. For decades he has railed about the US being taken advantage of by other nations when it comes to trade. In the 1980s it was Japan; today it’s China. His view of global trade is crude – he sees trade imbalances as terrible when they are often perfectly fine – but it resonates with many Republican voters who have seen US manufacturers shift jobs to other parts of the world.
In China, Trump has the perfect foil. The country has become the world’s factory over the past 20 years, pulling jobs from the US and elsewhere. Yet despite joining the World Trade Organisation membership in December 2001 it has thrown up non-tariff barriers to would-be international entrants while allowing copycat local businesses to steal their ideas and flourish.
Plus the Communist government in China is secretive and obsessed with control. Its leading businessmen are typically Communist Party members (including Alibaba founder Jack Ma and Huawei founder Ren Zhengfei), while the presence and influence of the Communist Party in Chinese-listed companies is often too unclear, according to a report by the Asia Corporate Governance Association.
Trump’s tariffs may lack finesse, but it’s hard for Beijing to claim that it's an innocent victim.
ASSET OWNER ATTACKS
While the US has legitimate reasons to be unhappy with China, expanding a trade war into the financial market is very risky. And corralling pension funds, insurance companies, endowments and others into an anti-China stance would be particularly unwise.
US asset owners have a fiduciary responsibility to ensure they maximise investment returns for their stakeholders. It would contravene this commitment were the US government or Congress to pressurise them to withdraw from Chinese companies.
It would also set an unwelcome precedent. After all, if asset owners were required to offer such high scrutiny of Chinese companies they may feel compelled to demand similar insight into the disclosure of companies listed from other countries, and even US ones. That could offer some benefits (increased disclosure could help on an environmental, social and governance basis, for example, while many Chinese companies should improve their transparency), but it would probably raise disclosure costs and that could hurt returns.
But the most damaging effect would be the reputational damage done by the overt hand of the US government on its own free market. The integrity and influence of its asset owners would be hurt were they to become seen as proxies of US policy goals – much as Huawei is discovering today.
China would also have an enormous amount of ammunition in any sort of financial stand-off.
The Chinese state owns about $1.2 trillion in US Treasuries or around 5% of outstanding issuance. Were financial frictions ever to really escalate it is possible that Beijing could sell off some of these assets. That could cause yields to spike and the dollar to weaken (although the Federal Reserve could probably absorb much of the damage).
Experts convincingly argue Beijing would be unlikely to want to do anything to damage the value of its own investments, but in the event the US was actively seeking to prevent investors from buying its companies, it may decide it has no choice. And of course the Chinese government could lean on its other investors, such as China Investment Corporation and its various insurers, to take countermeasures too, in assets as diverse as listed equities to real estate.
There are other simple measures that China could employ too. For example, the Chinese authorities could reverse their decision to let foreign asset managers and insurers take majority control of their onshore Chinese joint ventures. And cutting off US access to China's onshore market would be a very unpopular move among its asset managers and investment banks.
It’s worth stressing that these scenarios remain very unlikely. The financial advisers around the president will not want to completely upset the US’s financial applecart as they confront China over trade.
But the risk cannot be entirely discounted. Trump is notoriously unpredictable, often uncaring of consequences of his policies, and eager to show that he is a tough-guy leader.
While it’s unlikely he could pass legislation barring US asset owners from buying Chinese assets, Trump could use the issue to harangue both US asset owners and his Democrat political foes for a lack of patriotism. And even the possibility of such an escalation could hurt asset valuations, and asset owner returns.
Institutional investors in the US and China had best hope this trade war doesn’t turn financial. Because if it does, they will sit front and centre of the resulting battles.