Mark Williams

The US and China: From Ping Pong Diplomacy to Trade Wars

Mark Williams

Dollar vs Yuan 600

Fundamental ideological differences have defined relations between China and the US since the communist party took control in 1949.

Almost immediately, the pair were pitted against each other with China sympathising with the North Korean People’s Army when the Korean War began in 1950 while the United States intervened on behalf of South Korea. These tensions played out again during the Vietnam War. During this time China remained largely closed off from the rest of the world.


The first public sign of a thawing in relations came during 1971, when China’s table tennis team invited their US counterparts to the county in a move dubbed Ping Pong Diplomacy. In the same year, the United Nations legitimised the Chinese regime by handing the People’s Republic of China the permanent Security Council seat previously held by the Republic of China on Taiwan. From then, first under Nixon, then Carter and Clinton relations generally improved between the two countries (albeit with a significant freeze after Tiananmen Square) until, by 2006, China had surpassed Mexico as the US’s second largest trading partner, behind only Canada.


With China becoming the second largest economy in the world earlier this decade, US-Sino relations garnered ever more attention. Under Obama, the US announced a ‘pivot’ towards Asia that was seen as an open acknowledgement that it wanted to counter China’s increasing regional and global influence.


This was followed by the Trump era, which began fairly harmoniously, with a two day Mar-a-Lago summit leading Trump to herald “tremendous progress”. But, as has become his modus operandi, Trump then completely changed tack and announced the first of his tariffs in March 2018.


At the time of writing it remains unclear what Trump is looking to achieve from his enthusiastic imposition of tariffs. He has various advisors with differing aims, but we believe he is most likely to be targeting one of two results: treating China as a clear enemy, hoping to curtail the country’s longer-term development; or viewing it as a strong competitor, and looking to remove some of the unfair economic advantages that China has gained over the years. While his execution has been unique to say the least, if he is after the latter then there is some logic behind Trump’s strategy.


It is uncontroversial to suggest that China is not completely blameless in the trade tensions that have emerged.

The US Congressional Research Service has neatly summarised this for us. While noting that “China is currently the United States’ largest merchandise trading partner, its third-largest export market, and its largest source of imports” it lists a number of concerns among US policymakers as a result of China’s rapid growth: “Some claim that China uses unfair trade practices (such as an undervalued currency and subsidies given to domestic producers) to flood U.S. markets with low-cost goods, and that such practices threaten American jobs, wages, and living standards. Others contend that China’s growing use of industrial policies to promote and protect certain domestic Chinese industries or firms favoured by the government, and its failure to take effective action against widespread infringement and theft of U.S. intellectual property rights (IPR) in China, threaten to undermine the competitiveness of U.S. IP-intensive industries. In addition, while China has become a large and growing market for U.S. exports, critics contend that numerous trade and investment barriers limit opportunities for U.S. firms to sell in China, or force them to set up production facilities in China as the price of doing business there.”


“Made in China 2025” – an initiative to position China as a major player in key manufacturing sectors while reducing its reliance on foreign technology – will only heighten nervousness in some quarters of the US, providing support for Trump’s aggressive tariffs.


US tariffs against Chinese goods


US imports from China covered by special protection

As the charts show, the tariff situation has escalated rapidly.

We, along with many others, interpreted Trump’s early salvos as posturing designed to gain short-term favour with US voters rather than targeting longer-term containment of China. While Trump’s Trade Wars still smack of (re)electioneering, the dispute has escalated beyond our initial expectations and the likelihood of a quick win for Trump has receded.


So where does this leave us? Trade wars are destructive, and this one is worse than we would have predicted a year ago. There will certainly be long-term effects. For example, manufacturers with production in China are bound to expand capacity in other countries that are not subject to the tariffs. This represents extra investment cost that would not otherwise have been necessary. Not all costs from the dispute will be borne by China however. As all but the most commoditised goods can pass on a portion of taxes through higher prices, it is the US consumer as much as Chinese producers that is penalised.


Furthermore, what China sells to America is hard to replicate. Supply chains for electronics are long, making tariffs more likely to lead to inflation before alternative sources of production. Trump has implicitly acknowledged this domestic tariff burden when choosing to delay imposition of some of this year’s levies in order to provide temporary Christmas shopping respite.


Markets are very swift to discount events, however, and in most instances we believe they have overreacted to each incremental development in the tariff saga. This fragility of sentiment with respect to Trade Wars has led to investment opportunities emerging.

The Asia Income Fund’s Taiwanese holdings are a great example of this.

In 2018, 77% of Taiwan’s GDP came from exports. Taiwanese exporters, many of which are technology companies with Chinese manufacturing sites, appeared to be potential losers from tariff imposition, triggering double-digit share price falls in 2018’s first tariff sell-off. In this case, the market had overreacted. So far in 2019,

Taiwan has proven to be a beneficiary of the trade dispute. While shipments of machinery and electrical equipment (Taiwan’s main export) to China have fallen by 2%, exports to the US have increased by 33%. South East Asian countries such as Thailand are also benefitting from companies with Chinese production sites looking to secure alternative production elsewhere.

As the trade tariffs first escalated, we drilled down into the product ranges of the Asia Income Fund’s Taiwanese stocks’, modelling the bear case impact of tariffs – where the companies assumed the full economic impact. We also modelled a base case scenario which reflected our understanding of each company’s pricing power – meaning they could pass on some or all of the tariff to the consumer – as well as the ability to shift manufacturing to Taiwan or elsewhere in order to dodge the US-China tariffs.

For all of the stocks we owned in Taiwan, our analysis suggested that share price falls significantly overestimated the trade risks. We therefore added to all of these positions, an exercise that has to-date made a substantial positive contribution to the Fund.


The indiscriminate sell-off in Taiwanese export stocks is exactly the kind of market inefficiency that we look to exploit. Although the US trade offensive against China is undoubtedly a negative for the country and region, it is throwing up sufficient opportunities for us to remain bullish on the long-term investment prospects.

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Key Risks 

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in Funds managed by the Asia team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The Fund’s expenses are charged to capital. This has the effect of increasing dividends while constraining capital appreciation. 


The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing. 
Tuesday, October 15, 2019, 3:59 PM