U.S.-China tensions threaten great financial decoupling

Growing tensions between China and the U.S. are deepening the rift between the two rivals’ financial systems, a trend that could cut into the productivity of the global economy.

In the U.S., there have been moves to exclude Chinese stocks from large public pension programs. China has tightened regulations to prevent its companies from easily listing in the U.S. and elsewhere. These mark sharp reversals from the decadeslong internationalization of finance.

“The Communist Party of China is not a vehicle that we want to be entangled with,” said Ron DeSantis, governor of the southern U.S. state of Florida, in a news release announcing a “a survey of all of the investments of the Florida Retirement System to determine how many assets the state has in Chinese companies.” The FRS is included in the roughly $250 billion in assets under management by Florida’s State Board of Administration. Hard-liners against China have long argued for a retreat from investing in the country, arguing that pension money would be diverted to businesses with military ties.

DeSantis is a leading player in the opposition Republican Party. With a Navy background and a law degree from Harvard University, he is often mentioned as a possible presidential candidate in 2024. His move can thus be seen as a calculated appeal to the party’s conservative base ahead of the crucial 2022 midterm congressional elections. But pension funds across states in the eastern part of the country are ready to do the same as they receive similar requests from organizations and individuals to review Chinese investments.

In an America where Democrats and Republicans are sharply divided on many issues, a hard line on China increasingly draws support across party lines. The U.S.-China Economic and Security Review Commission (USCC), for example, was established by Congress on a bipartisan basis. Its recommendations were the foundation for the regulatory crackdown on major Chinese telecommunications equipment suppliers. Its 2021 annual report, issued in November, discusses “tightened U.S.-China financial connectivity.”

Florida Gov. Ron DeSantis has been spearheading a move to have state public pension funds disinvest from China. © Reuters


The report recommended that Congress require the Treasury Department to supply “an annual update of the accurate U.S. portfolio investment position in China,” including exposure for “U.S. institution types, such as state pension funds” and individual Chinese recipients “who receive more than a minimum amount, such as $100 million.” Venture capital and private equity disclose little information, and it is impossible to verify whether they are investing in Chinese companies that could pose a security threat. Florida’s move to review the management of its public funds can be viewed as a response to the USCC recommendation.

Even the flow of money passively invested in stock indexes cannot be ignored. MSCI said in 2017 that it would include mainland-China-listed stocks, specifically large-cap China A-shares, in its main index. Some in the market were cautious, but the Chinese government is said to have lobbied for this. According to data from the Institute of International Finance, inflows from abroad into Chinese stocks have been increasing since 2018.

U.S. public pension funds have a high ratio of passively managed investments, resulting in returns swayed by the composition of stock indexes. The California State Teaching Staff Retirement Fund, with a $327 billion portfolio, showed the percentage of its assets under management by region at an internal investment meeting in November. China, including Hong Kong, was 2.2% by market capitalization, closing in on the 2.6% of second-ranked Japan and the 2.5% of the third-ranked U.K. The percentage of sales by region for stocks held by it has already exceeded 10%.

Hard-liners aim to halt this trend. When Donald Trump was president, the U.S. prohibited investment in military-linked Chinese companies — a ban extended by the Biden administration. The Securities and Exchange Commission has introduced rules making it difficult for Chinese companies to list in America. In its report, the USCC recommended that index providers that include Chinese stocks, like MSCI, be regulated by the SEC.

China is also moving in the opposite direction of capital liberalization. The authorities’ pressure on Didi Chuxing, a major transport app provider that had a New York listing, and the subsequent restrictions on overseas listings reflect concerns over foreign capital possibly threatening Communist Party dominance. China is promoting the development of an environment where companies can raise funds for growth at home, including through the establishment of a new stock exchange for small and midsize businesses in Beijing.

Cliff Kupchan, chairman of New York-based risk analysis firm Eurasia Group, notes that China is trying to internationalize the renminbi. “China hopes that its efforts to entice other forms of capital will allow it to internationalize the renminbi,” he says. “That drive is unlikely to challenge the dollar anytime soon but could over decades.”

Traders work during the initial public offering for Chinese ride-hailing company Didi on the New York Stock Exchange floor in June 2021. © Reuters


Sino-American financial ties have strengthened over the past decade. U.S. investors held nearly $1.2 trillion in Chinese equities and debt securities at the end of 2020, while Chinese investors held as much as $2.1 trillion in U.S. equity and debt securities, U.S. research firm Rhodium Group estimates. China has long hesitated to liberalize its capital markets, lagging behind global financial integration, but has gradually eased restrictions.

For China, the U.S. is an important financial trading partner, and Chinese companies have relied on it for financing. On the other hand, institutional investors and individuals in the U.S. have turned to China in search of higher returns.

“Under normal conditions, there would be room for trillions of dollars in additional U.S.-China financial investment before balances reached levels typical of advanced economy pairs,” according to a 2021 report by the U.S.-China Investment Project, which Rhodium co-leads.

Finance, which involves the exchange of risk and return, has been globalizing for decades because it is more efficient when as many investors as possible participate. But if financial decoupling continues as a result of political conflicts, it will throw a wrench into the engine of global growth as the cost of capital increases.

In mid-September 2021, a meeting of the U.S.-China Financial Roundtable brought together leading Wall Street figures and Chinese officials. The event got its start in the Trump era, and this was its first time being held since the change of administrations. The aim is to find a way to resolve brewing issues behind the scenes. But during the four years of Trump, a confrontational structure was created that made it difficult to communicate effectively, an American attendee lamented.

How to bridge the money divide has yet to be discovered.


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