July 23—Rising trade tensions in the past few years saw half a trillion dollars in tariffs by the U.S. on Chinese goods and retaliation in kind. Then came COVID-19 and a whole other kind of blame game ensued. In Part II of our discussion on China, Tony and Dr. Stephen Roach, Senior Fellow at Yale University’s Jackson School of Global Affairs, discuss whether U.S.-China relations have reached a tipping point.

Tony Roth: Welcome to Wilmington WealthWise, the podcast dedicated to financial literacy where we take complex ideas from the investment world and make them accessible to everyone. I’m your host, Tony Roth, chief investment officer of Wilmington Trust.

We are in the foothills of a cold war. That’s what Henry Kissinger told a Bloomberg reporter at an economic forum in Beijing last November. In the past two years, we’ve been on a rollercoaster in terms of our relationship with China. We’ve had a trade war that has taken the form of the U.S. slapping tariffs on around $550 billion of Chinese goods headed towards the U.S. and China leveling around $185 billion of U.S. products with their own levies.

So, we’re back here today with part two of our two-part spotlight on China. Last episode, we focused on China’s rapid economic growth since the 1970s and what it must do to sustain that level of growth moving forward. In this episode, we’ll address some of the challenges China’s facing as it pushes into the future, especially as it relates to the tricky relationship between the two largest economies in the world, the U.S. and China.

Joining us again, we’re very privileged to have Dr. Stephen Roach from Yale University’s Jackson School of Global Affairs. Stephen, thanks for sticking around for part two.

Stephen Roach: Thank you, Tony. I look forward to pushing this debate a little bit further into the real-time tensions that are playing out between these two large and critically important economies in the world.

Tony Roth: Before we jump into the discussion, I do want to remind, again, our listeners that WealthWise is completely nonpartisan and we take no political position one way or the other. So, with that in mind, let’s get started.

So, Stephen, we kicked off the first episode by discussing China’s phenomenal growth story over the last 40 years. It’s become a major trading partner for the U.S. and when we look at the fact that we have the two largest economies in the world embroiled in this significant trade conflict with very deep geo-strategic undertones that relate to Hong Kong and Taiwan, somewhat exacerbated by COVID-19 in certain respects, it’s somewhat reminiscent of this frosty relationship we had with Russia where we were barely on speaking terms.

How did we get to this point? It seems to have gone so terribly wrong. And do you think that we can pull the relationship back to a healthier position?

Stephen Roach: Well, we can hope so. But, you know, the bottom line is. This is a relationship problem. In a book I wrote several years ago, I looked at the U.S.-China tensions that, back then when I wrote the book in late 2014, early 2015, had really not become a serious problem.

But I framed the relationship in sort of the human behavioral model of codependency when two partners in a relationship become so reliant on one another that they begin to lose sight of their own journeys. And so, when one partner decides to address that problem and go its own way, the other one feels scorned, left behind, and lashes out.

I will admit, it’s a stretch to frame economic relationships from a human behavioral perspective, but it enabled me to speculate that a problem was coming, because China was changing its growth model. We talked about that in the first episode, moving from exports and investment as key sources of growth to internal private consumption.

And this change in China’s economic character has really not been accompanied by any meaningful shifts in America’s own economic agenda. And so, the conflict that has emerged is just as much an outgrowth of some of the vulnerabilities in the U.S. economy as it is an outgrowth of the allegations that have been made with respect to China’s alleged unfair trading practices, especially in the technology and innovation areas.

So, we, in addressing the tensions there are issues we can certainly focus on with respect to China. But, there’s a lot of stuff that we need to look at ourselves that are a reflection of our own economic issues.

Tony Roth: So, before we get to our issues, let’s focus for a moment further on China. And that’s how we ended the last episode around the line between fair and unfair technology use. And again, you’ve talked about the critical importance for China to be able to create a base of domestic innovation, technology innovation, in order to not get caught in this so-called middle-income trap and to build the method and the processes to continue to innovate on a going forward basis.

So, certainly there are things that are malicious or that seem to be clearly unfair. If one company hacks another company’s web and they steal, clearly steal trade secrets, that’s not fair. But then, you have a lot of like our so-called, these forced technology transfers. Let’s say that a U.S. company wants to build airplanes in China and China says, okay, terrific. You want to build airplanes here. Sign on the dotted line. And what this agreement says– you’re going to get from us this great market to be able to sell your airplanes. You’re going to get some labor from us, perhaps at a better rate than you could get domestically in your country. But we’re going to get in return some technology. And you don’t have to do it. No one’s forcing—no one’s holding a gun to your head. You don’t have to sign. But, if you want to sign, then there’s a transfer.

Is that forced in some type of untoward way? Or is that the way business works? When you really break it down and you talked about Ambassador Lighthizer’s report in the last episode and whether or not there’s really a lot of untoward practices going on. How bad is China’s behavior today, do you think?

Stephen Roach: Look. I’m certain that there have been examples of bad behavior on both sides of this critical issue. But, you know, just going back to the allegations made by U.S. Trade Representative Robert Lighthizer, in his so-called Section 301 report of March of 2018, where he laid this out with great detail, he basically admitted that he had no hard evidence whatsoever that the technology transfers that do occur under joint ventures have in fact been forced, as you just alluded to.

A joint venture, I mean, you know, what is it? It’s a commitment by two partners to build a shared business. And in implementing the strategy to build that business under shared ownership, of course there is a comingling of talent, strategies, ideas, distribution channels, and even from time to time some proprietary technology.

But again, as you alluded to, this is a voluntary agreement. No one forces you to sign. And the idea that, you know, there has been pressure, that remains to be seen.

In the interest of full disclosure, I was a board member of a joint venture in China in the early 2000s, a joint venture formed by my former employer, Morgan Stanley, and a leading bank in China, the China Construction Bank. Together we built China’s first investment bank, CICC, China’s International Capital Corporation. And I participated actively in very complex discussions and strategy development with Chinese partners. And at no time was there any forcing of the sharing of our financial technologies, proprietary products that we had developed at Morgan Stanley.

My travels in China, living there and participating in business discussions with a number of different industries, both on the U.S. side and the Chinese side, the notion that these transfers were forced, done through coercion with all but a few exceptions, mainly in the pharmaceutical areas, that impression, I think, is really one that is extremely difficult to substantiate. Your airplane example, Boeing, our largest exporter to China, relies on at least two joint ventures. And they set up these joint ventures to deal with parts of aircraft assembly rather than turning over the critical components of how to design and fly an airplane.

They’re—these are smart businessmen. They know what they’re doing. They’re not going to just open up the keys to the kingdom just to do business in China.

You’re right to focus on this as an important issue. But, it’s one that I think does not really withstand careful scrutiny in terms of the veracity or validity of the charges that are being raised by the Trump administration.

Tony Roth: Within the last two days we received a report from China around its economic growth that shows that the Chinese economy is recovering very nicely from COVID, almost like a V. And, indeed, all the global markets, including the U.S. markets cheered that news.

So, we want the Chinese economy to grow. We want China to be bigger so it becomes a bigger market for us. These economies are very interconnected. The healthier that one is, the healthier the others are.

So, what is it that we’re really so upset about? In other words, you’ve written very articulately around our own problems, probably the most leading one being our massive and growing current account deficit. Is it that we’re really concerned about our current account deficit and we’re sort of blaming it on China? Is it that we’re afraid of China’s hegemonic tendencies in terms of their dominion over that part of the world, South China Sea, Taiwan, etcetera? Where should our attention really be focused in terms of our relationship with China?

Stephen Roach: I would touch on a few issues that you just raised in posing that question. Number one: our current account imbalance. We run a deficit on our balance of international payments, the current account, in large part because our domestic saving rate, the sum total of savings of households, businesses, and the government sector is anemic.

Prior to the outbreak of the pandemic, our domestic savings rate net of depreciation, which is what you want to look at to get the saving that’s available to fund economic growth, it was only 1.4% of national income in the first quarter of 2020. And now in this era where we’re just going from already large deficits and low saving to an explosion of budget deficits, the likes of which we have never experienced that will take our domestic savings rate deeply into negative territory, which means we’re actually liquidating our saving, our current account problems are going to get more and more acute.

When you run a huge current account deficit like we have been doing and like it’s going to go from bad to worse in the years immediately ahead, you run trade deficits to attract the foreign savings from abroad and you run them with many, many countries. Last year, 2019, we had trade deficits with 102 countries around the world. China was the biggest, yes. But by higher math that leaves another 101 countries.

And so, we have a multilateral problem and unless we address the weak saving that drives that, attacking one trading partner will simply mean we’re diverting our trade deficit from a low cost producer like China to higher cost producers around the world. And that’s the equivalent of a tax hike on American businesses and on American families.

So, the Trump administration and other administrations as well have, I think, really missed the boat here in attempting to reduce the bilateral trade deficit with China in a world afflicted with a multilateral trade imbalance. You can’t fix a multilateral problem with a bilateral approach.

Tony Roth: I can’t help but asking you about some of your recent views on the dollar, because your emphasis on our poor savings rate and our current account deficit has been integral to your view on the dollar.

Stephen Roach: Well, the dollar’s had a great run since the end of 2011. But that run is over in my view. The dollar was up about 27%–28% from late 2011 through early 2020.

I look for the dollar to drop 35% over the next couple of years, the dollar index that is, reflecting, one, this explosive growth in our current account, the deficit that I alluded to earlier, but secondly, our unfortunate squandering of our leadership role in the world. We’re leading the way in deglobalization, decoupling, trade protectionism.

We’ve pulled out of major global institutions from the World Health Organization. We’ve been threatening to do the same with our North American Treaty Organization, NATO, WTO. We’ve pulled out of the Transpacific Partnership in the first few days of the Trump administration. And we are doing a terrible job relative to other major economies in addressing the coronavirus. Our performance for a country of our stature is nothing short of appalling compared to other major countries. And finally, you know, this racial catharsis we’re going through is certainly one that draws our own leadership and lack of vision into serious question.

So, for the multiplicity of reasons, I think the dollar is headed lower. When I made this call a couple of months ago, I received more than a usual amount of hate mail that I get. And the questions were like, you know, if you don’t like the dollar, who, who’s going to benefit, and there’s no other place in the world where investors would like to put their money. And I totally disagree.

I think the euro is the most unloved major currency in the world and it’s been very weak over the last seven or eight years. And I think euro is headed higher, especially in light of the recently agreed compact of Angela Merkel of Germany and Emmanuel Macron of France to establish this Next Generation EU Fund and begin the process of issuing a sovereign Pan-European bond that would begin to challenge treasuries as risk-free assets.

And I also like the Chinese renminbi, which has appreciated 51% on a broad trade-weighted basis since 2004. And if China stays the course on reforms, there’s plenty more to go there as well.

So, the dollar’s not the only game in town. A 35% drop seems like a large number, but the dollar fell by 33% in the ‘70s, 33% again in the mid-‘80s and about 28% in the early 2000s. And so, you know, I think we’re headed down again.

Tony Roth: Every president makes mistakes, obviously. But certainly, one of the early and big mistakes made in this administration was the withdrawal from the TPP. And the broader idea is that the Chinese relationship seems to be one that would really emit of a better outcome through a multilateral rather than a bilateral approach given our putative aims. Just tactically, it seems that trying to go it alone versus the Chinese has been a tough course to try to take.

Looking at China; when you look at some of the things that they’ve done, whether it be the One Belt and Road initiative, where they’ve gone around the world and try to really insert themselves into the infrastructure developments of other countries, Do you think that China is untowardly hegemonic, which is a word I used earlier, that they have unrealistic ambitions of dominance? Or do you think that their behavior is sort of in line with what one would expect from a—the second largest economy in the world looking to do better?

Stephen Roach: The honest answer is we don’t know. Historically, China has not had great territorial ambitions, although you see what they’ve been doing in militarizing the South China Sea following earlier tensions in the East China Sea with Japan, recent skirmishes on the Indian border. Those are disconcerting developments.

China definitely has aspirations to achieve great power status by the year 2050 or 2049 to actually be precise to mark the 100-year anniversary of the founding of the People’s Republic of China. But these aspirations don’t say that China wants to be the dominant power. They simply want to be sitting at the table with what they would perceive to be other great powers.

Certainly, there are a number of issues that disturb observers in the West with respect to China’s behavior. I think the economic tensions are more of a foil, as I alluded to earlier, for some of the problems in our own economy. But, you know, the tensions in Taiwan and certainly in Hong Kong, in light of the new recently enacted National Security Bill by the PRC, the problems with ethnic minorities in the remote Western Province of Xinjiang, you know, these are big issues. They don’t necessarily, however, lead you to conclude that China is after hegemonic domination. They do speak, however, to a China that is certainly not behaving in ways that are consistent or well-aligned with the norms as we know them in the West.

Tony Roth: So, where do you see the opportunity going forward? Do you see it associated with primarily a change in power in Washington? Do you see opportunities either way after the election and what are the major opportunities that you see?

Stephen Roach: Well, like I’m a big believer that we, number one, need to recognize the stakes of a deepening conflict, and number two, need to do everything in our power to avoid that. I am hopeful that we can return to more constructive engagement. But to do that, we need some specific targets or goals in mind.

Number one, a bilateral investment treaty: A bilateral investment treaty or a BIT is something that countries have used all over the world for a number of years to open up their markets to each other. China wants to get into our market. We want to get into China’s market. Nothing would benefit our multinationals more than having a piece of the world’s largest growth story.
And by doing that, we could provide a rules-based system of access to their markets and their access to ours that would eliminate the need for foreign investment caps and take the technology forcing issue from joint ventures off the table, because there wouldn’t be joint ventures anymore. So, let’s do a bilateral investment treaty.

Secondly, we need to really address the cyber issue jointly. Certainly there’s been allegations going back and forth on this one for a number of years. Both countries hack. China is always singled out for being particularly aggressive here. But this is a global problem, not a bilateral problem, and we could take the lead in forging a global cyber security issue.

Thirdly, we need to save more, China needs to save less, and that will take the trade imbalance issue out of the equation. And fourth and finally is the nature of the dialogue. We don’t talk on a high-level constructive basis on a regular basis and that’s too bad. We used to have these strategic and economic dialogues. We’ve given up on that and we need to go back to a more permanent office that houses senior officials on both sides that are working full-time on this relationship. And if we do those four things, or I, look, I’d take two of the four, I think we’d be able to get this relationship on more constructive terms than it is today.

Tony Roth: And just in the very short-term, the last question, a very tactical one. We, of course, did have these three years—two to three years—of angst in the markets around this idea of a trade deal with China and we reached this so-called trade—phase one trade deal. And while there’s not really a prospect of a phase two trade deal, we do have a mandatory review of the phase one deal coming up in August. Do you expect anything material to come out of that process that would move the needle either in terms of our relationship or in terms of the political environment one way or the other or is that more of a formality in your mind?

Stephen Roach: I don’t expect anything big to come out of this. Unfortunately, I thought phase one was a bogus deal when it was signed in January 15th of this year. It was – it violated the very point I stressed earlier in these discussions trying to resolve America’s multilateral trade imbalances with 102 countries by putting pressure on China to reduce its bilateral deficit with us. That would’ve accomplished next to nothing.

And if you look at the purchase trajectory of the Chinese of the goods they were supposed to buy under phase one, they’re well short because of COVID and other factors. So, this is not, you know, an effective way to resolve our differences.

Tony Roth: Terrific. Well, let me take a stab at summarizing for us what I think the three key takeaways are from the episode. And I’ll start with I think there’s been a big emphasis here today on our what we call the current account deficit, the trade deficit. But, it’s not just with China. It’s with the world broadly speaking. And that deficit itself, which is essentially funded by borrowing from other countries, is really going to imperil our own growth at some point and will also imperil the dollar. So, it’s something that we have to keep a very close eye on, particularly in the context of these rescue packages, which are certainly necessary right now, but nonetheless adding to the problem in the COVID environment.

The second thing is that there is a very critical dance on the technology arena between the U.S. and China as it relates to innovation, as it relates to the potential to work together but also the potential to protect those ideas and innovations on each side of the relationship. And as we see how this plays out, we’re going to have to be very, very careful that this could just drive a very lasting wedge between the countries or it could, through the kinds of investment that you’re talking about, be an opportunity for us to work more together and to dial down the conflict. So, we’ll see what happens there.

And the third takeaway is simply the need for a more constructive and potentially a multilateral approach to dealing with the relationship with China, China’s ascendency, and indeed our own trade imbalances, in the world. And that regardless of who is leading our country that may be an approach that may be more fruitful for us moving forward.

So, we’ll continue to watch these issues very carefully. Stephen, I just want to thank you again for your insights over these two episodes. It’s just been a great pleasure to have you.

Stephen Roach: Thank you, Tony, and I appreciate the breadth and depth of your questions. And this is a big issue and there’s rest assured a lot more to come.

Tony Roth: It’s an interesting area to be an expert on. You’ll never get bored. Thank you to our listeners. Feedback always welcomed at wealthwise@wilmingtontrust.com. And finally, please go to wilmingtontrust.com for all of our latest thought leadership, blog posts, media releases, etcetera, within the investment arena. Thank you all very much. Goodbye.

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Dr. Stephen Roach, a Senior Fellow at Yale University’s Jackson School of Global Affairs

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