Ever since President Donald Trump’s first salvo of tariffs against China in 2018, the relationship between the two countries has turned sour. While tariffs were placed on steel, aluminum, cars and the like, the real impact to China was semiconductors. If China could be cut off from technology advancement, they could be cut off from anything else they have come to depend on the west for. This has driven them, in my opinion, to decouple from the west and become self-sufficient.
In fact, this might explain why the Chinese real estate market crashed and so many investors thought that China was uninvestable. From 2012 through 2018, new loans generated for real estate purchases increased annually from 1 trillion renminbi to a peak of 6.5 trillion. Over the same period, industrial lending in China was flat. However, when tariffs were announced in 2018, lending to the real estate sector collapsed while outstanding industrial lending doubled from ~10-12 trillion renminbi in 2018 to 21 trillion in 2023. This went unnoticed to many investors.
China already had a national industrial policy in 2015 titled “Made in China 2025” (MIC for short) which was explicitly designed to build domestic capabilities in high-tech sectors and reduce reliance on the West. The 2018 tariffs accelerated MIC as it leveraged and intensified the plan. Since they went full steam ahead (and I know Americans hate to hear this), China has leapfrogged the US in many industrial and technological areas. Today, China has a dominance in EVs, solar, and batteries to name a few. The tension this has created between the two nations looks worse than ever before, but I think there is reason for optimism in the midst of the storm clouds.
For one thing, China has some serious economic concerns that are a by-product of the real estate bust they experienced. Many Chinese citizens’ net worth has taken a massive hit as they lost a lot of wealth with property values sinking which has also affected consumer confidence. This has triggered many to become ‘savers’ rather than ‘spenders’ which has translated in a vicious bout of deflation hitting their country. To stop deflation, the government is doubling down on industrial spending hoping that workers won’t continue to save too much of their earnings. So far, this has not worked, and prices remain flat to negative. Further, with excess capacity at home, they have been exporting products worldwide which has been a major concern of the US and EU as the West cannot compete with China’s low prices.
Second, and arguably the biggest concern for China is the low birth rate and declining population. Reality has set in as the government is now taking steps to encourage more babies that include financial incentives, social support and cultural shifts. Nothing has improved the situation and arguably, the data has remained an unmitigated disaster despite the efforts. There are many reasons to think any future efforts will also fail. Chinese millennials prefer city life where the average square footage of an apartment is 650-1,050 sq ft. Suburbs in China also are not similar to suburbs in the US and often still consist of high rise living with small units in which families live. Raising more than one child in such a small space is a roadblock in and of itself. Moreover, many Chinese millennials were taught from a young age that culturally they were only allowed to have one child. Not only did they never experience a household with siblings, but many also have no cousins either. Lastly, their balance sheets have been damaged with the real estate bust which is yet another headwind to a bigger household.
Fort Monroe Doctrine
In May and June, I discussed what I believed to be that the world was fracturing into three distinct economic zones that will be defined by tariffs, protection laws and security/defense. For the US, it was a focus on Latin America or the Fort Monroe Doctrine. The reasons seem simple enough but execution difficult. The US wants to become self-sufficient (like I discussed with China above) but needs resources from Latin America to break away from Asia. There is further evidence of this occurring the past few weeks. Consider the following:
- In Argentina, Javier Milei’s party sustained an electoral defeat which ushered in a wave of panic among investors. Many headed for the exit based on the country’s history of defaults and devaluations. Historically, US administrations sat back and watched especially since the US has very little national interests in Argentina. But not this time. US Treasury Secretary Bessent stepped in to offer a backstop to their plunging currency and bond market from collapse. Yes, it is entirely possible that the move was ideological, but the point is that the US now cares more about what happens in our backyard. Could a deal be established to provide currency support in exchange for access to Argentina’s lithium mines and a rejection of Chinese infrastructure and agriculture deals?
- The US administration isn’t hiding it anymore; they want regime change in Venezuela. A $50 million bounty was placed on Nicolas Maduro’s head, and a secret directive authorized the attacks on drug cartels in Venezuela. This has led to a military buildup including naval assets, marine expeditionary units and fighter jets in Puerto Rico. It appears the strategy is to target narcos and cut off the regime from a source of funding. This is a provocative move that goes well beyond the typical sanctions placed and re-emphasizes the point that the US is pivoting to South America to secure our backyard.
- There was a leaked report from the Pentagon that seems to indicate that the unfolding spending reviews focus on preparing the US military to defend the Western hemisphere rather than maintaining a global presence. I wrote about this back in June when I emphasized that in an era of drone warfare, million-dollar missiles protecting billion-dollar ships are no longer viable against thousand-dollar drones.
- President Trump’s recently made comments about Ukraine winning all their territory back from Russia “with the support of Europe and NATO”. There is no mention of “support of the US” which leads to me to believe, that he is washing his hands of the conflict. He continues: “We will continue to supply weapons to NATO for NATO to do what they want them. Good luck to all”. I’m speculating, but it feels as if he is saying “I tried to bring peace, and it won’t happen. So, we will make money instead by selling weapons.”
With the evidence mounting that the US is folding back into the Western Hemisphere, markets have taken notice. Bull markets are springing up in both Asia and Latin America. If the US is willing to step in and provide support to regimes it deems friendly in the south, it dramatically reduces the risk of investing in those countries. Meanwhile, China continues its heavy infrastructure and industrial spending to neighboring countries.
Narrative Shift
All of which brings us to September with the Chinese leadership hosted Putin and Modi where they hugged it out on stage, announced Power of Siberia 2 and India showed willingness to work with China. Against this backdrop, the Trump administration has acquired stakes in a rare earth metals company to begin to reduce dependence on exports from China and the Pentagon is reportedly considering drafting a new defense strategy towards Latin America; a striking reversal from the US military’s years-long obsession with China.
So where does the US-China relationship go from here?
Conventional thought would suggest that the most likely scenario is the current tense status quo persists. The US remains concerned about China’s rapid industrial rise (both in quantity and quality) and deeply unhappy about the dependence on China rare earths and magnets. Meanwhile, China is feeling less constrained by the US as shown in their PoS2 deal and thawing relationship with India. In this scenario, China will not provoke the US too directly so as long as the US avoids provoking China (notice how there is no more talk about the invasion of Taiwan?). In this scenario, Asian equities should continue to outperform.
Alternatively, and a very unconventional thought, Xi and Trump could finally meet soon. Perhaps as early as later this month (October) at the APEC meeting in Seoul where they could work out a more lasting deal. Both countries have bigger priorities, China has a population and consumption problem while the US has an industrial and debt problem. The potential deal could include an agreement for China reduce their involvement in South America and the US to reduce their involvement in Asia (Taiwan in particular), a reduction of tariffs, stronger renminbi, a commitment by China to buy US Treasuries and lastly, an offer for specific Chinese manufacturers to build in America (i.e. battery manufacturers). Under this scenario, the US should continue to see its aging bull market keep chugging along and the young bull markets of Asia and Latin America gain steam.
In any event, the baseline for every investor I’ve talked to this year is that that the relationship will not improve between both countries. Barring an invasion into Taiwan (which I’ve argued to clients would not happen over the past few years), I see the current situation as Glass Half Full. Both countries have significant internal challenges and strategic refocusing points that would benefit greatly if they came to a mutual deal. Arguably both Trump and Xi care more about business and money anyways, than waging war. Therefore, in my view, I stand in the minority when I say that I believe the relationship will improve from here.
