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Politics and economics have come to a head for China, the US and the EU

Politics and economics have come to a head for China, the US and the EU
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Verbally, Europe and the U.S. are adopting the same attitude towards China at this point. A few years ago, the European China strategy attributed three roles to China: partner (for example, concerning climate change), economic competitor and strategic rival (considering geopolitical ambitions of Beijing and divergent ideological systems). U.S. Secretary of State Anthony Blinken phrased the attitude towards China as follows: “competitive when it should be, collaborative when it can be and adversarial when it must be.”

China has been the main driver of the global economy in recent decades. It played a key role in shaping globalization and provided the West with the opportunity to keep up ultra-loose fiscal and monetary policies due to downward pressure that Chinese labor and products have exerted on global inflation.

China first and foremost represented an economic opportunity — geopolitical concerns would be dealt with at a later stage. Later has become now. This makes Western leaders nervous. The West and China are increasingly in direct competition with each other, while they would previously mainly complement each other. This could have major consequences for Western economies — especially for companies with interests in China, supply chains, inflation and the divergence in economic growth between the U.S. and Europe.

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Tensions over Beijing's authoritarian line have led to mainly symbolic sanctions by the U.S. and European Union. China has responded with measures against a number of Western think tanks, diplomats and others. These diplomatic pinpricks aren’t the only consequences, there are also economic repercussions. For example, China shut down H&M's website in retaliation for the Scandinavian company's critical tone about Chinese human rights. Also, a number of shops have been closed.

For a long time, the West has managed to avoid an excessive intertwining of political and economic components in its trade with China, for better or worse. This is becoming increasingly difficult. As a result, Western companies with a major public profile in particular will harbor more and more doubts as to the extent to which they should have a presence in the Chinese market.

First of all, it could generate very bad PR for them in their home market. Secondly, they could easily become a target for Beijing’s attempts to demonstrate decisiveness to its own people.

At the same time, the Chinese economy has become by far the largest market for many Western companies, therefore those companies will only consider withdrawing from China if all else fails. If tensions continue to rise, however, a 'China discount' could creep into shares of Western companies with large stakes in China.

Companies that achieve most of their sales in China include hotel/casino chains Wynn Resorts (roughly 70 percent of sales in 2019) and Las Vegas Sands (61 percent of adjusted earnings before interest, taxes, debt and amortization (EBITDA) in 2019) and tech companies such as Qualcomm (65 percent in 2019) and Broadcom (48 percent in 2019).

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Many car manufacturers and luxury brands have also become very dependent on China. In 2019, the Volkswagen Group achieved more than 40 percent of total car sales over there.

Split-offs — where companies divide business units and offer shareholders separate stock options for each new unit — could be in the offing if they wish to avoid ‘China discounts’ in their shares. These split-offs would contribute to the economic bloc formation that is already being feared by many experts.

The dependence of the West and China on globalization is enormous. China imports most of its oil, gas and iron ore. In addition, China largely relies on vulnerable straits for its supply lines, which are generally dominated by countries with which relations could be better. On the other hand, China still controls global rare earth production. Western countries are hastily trying to catch up, but this will probably still take about ten years.

Many believe the tensions will not come to a real clash precisely because of this mutual dependence. This could be the case — although World War I proved that this did not keep countries from going into war — but politicians are increasingly concerned about vulnerable supply lines and production chains. The Taiwan Semiconductor Manufacturing Company, for example, controls more than half of semiconductor production worldwide.

Policymakers and companies will try to diversify production chains and they might try to be less reliant on Asia. This will lead to less efficient, but hopefully more reliable supply chains. However, additional built-in security comes with higher costs, exerting upward pressure on inflation.

Meanwhile, China is shifting from an industrial export economy to a high-tech consumer society. The Chinese model of state capitalism could prove less suitable for these technological leaps than it was for the transition from an agricultural to an industrial economy. Moreover, China’s total debt rose to 318 percent of GDP in the first quarter of 2020. This is unprecedented for the current phase of China's economic development, rendering the country vulnerable to bursting asset bubbles.

China's ambitions have already made Western countries very suspicious of the role of Chinese telecom and technology companies in strategically important sectors. Keeping companies such as Huawei out of sensitive sectors is very costly — mainly because of Huawei’s already deep involvement in some countries. Almost nobody disputes that Huawei delivers excellent equipment at competitive prices. Switching to other suppliers will therefore result in higher costs. This, too, is a political development that could boost inflation.

Lastly, as tensions between the West and China will rise, Europe seems more sensitive to the following than the U.S.:

Andy Langenkamp is senior political analyst at ECR Research which offers independent research on asset allocation, global financial markets, politics and FX & interest rates.