Will the US be cautious on financial decoupling from China?

Hello from Washington, where President Donald Trump is busy touting the resurgent US stock market and America’s “transition to greatness”, even as the US pandemic death toll is about to hit 100,000 and certain areas, including the DC region, are still very much hotbeds of infection.

For all of Trump’s wishful thinking about a quick bounceback, most policymakers and economists discounted a V-shaped recovery a while ago, though strong housing data on Tuesday offered a glimmer of hope. One might have hoped that in this environment US-China tensions would have ebbed, with Washington and Beijing even considering some tariff relief as economic stimulus. Far from it, of course: the phase one deal signed in January is in jeopardy, and financial separation is firmly on the table, which is the theme of my column today. Our chart of the day looks at falling US imports from Europe, while our person in the news is Edward Yau, Hong Kong’s commerce minister.

‘The gloves are off’

During more than three years of escalating US-China tensions in the Trump era, officials in Washington have always calculated that they had two big sources of leverage over Beijing. The first was China’s need to access America’s large consumer market to fuel its export machine, which US officials were willing to threaten by imposing tariffs on $360bn of Chinese imports. 

The second was China’s thirst for its companies to be financed in global markets, which are still heavily dominated by the use of US dollars: and on that count, Washington largely pulled its punches, amid fear of the disruption that separating those investment flows might trigger.

But mounting rage within the White House and Congress at China’s handling of Covid-19, and its move to impose a strict new national security law on Hong Kong, has changed the equation when it comes to decoupling the capital markets of the world’s largest economies. From being a fringe issue being pushed by the most ardent hardline China hawks in the US, it is now being openly discussed as a way to both punish Beijing and sever more links with the Asian nation. Some policies have moved forward as well.

The White House recently instructed the government’s largest pension fund to stop investing in an index that contained certain Chinese companies deemed to have ties with the country’s security apparatus. US lawmakers are considering legislation that could lead to the delisting of Chinese groups from American exchanges for failing to abide by American accounting standards — a drive that was accelerated by the Luckin Coffee scandal. According to Bloomberg News, the US Treasury is also considering sanctions that could lead to asset freezes against Chinese businesses and individuals connected with the Hong Kong law.

US companies may be forced to abandon their hubs in Hong Kong © Chan Long Hei/Bloomberg

Senior US officials have even suggested that US financial groups and multinationals may be forced to abandon their hubs in Hong Kong, questioning whether the city-state special status can be preserved if Beijing presses ahead with its crackdown.

“I just don’t see how they can stay,” Robert O’Brien, Mr Trump’s national security adviser, said in an interview with NBC on Sunday. “One reason that they came to Hong Kong is because there was the rule of law there, there was a free enterprise system, there was a capitalist system, there was democracy in local legislative elections,” he added.

O’Brien suggested Beijing had everything to lose in an unravelling of financial ties between the two nations. “[China] is dependent on liquidity and financial markets. If they lose access to that through Hong Kong, that’s a real blow to [President] Xi Jinping and the Chinese Communist party.”

Nonetheless, it’s safe to assume that the US administration will proceed very cautiously in challenging China in the financial arena, slowly tightening the screws rather than mounting an all-out decoupling offensive. Before the Hong Kong law furore, US officials, including Steven Mnuchin, the US secretary of the Treasury, had already ruled out the radical option of questioning America’s debt-related payments to China, which would have rattled Treasury markets and undermined the Federal Reserve’s effort to keep them afloat during the coronavirus crisis.

Other clampdowns on Sino-US financial flows run the risk of leading to a new dip in equity markets at a time when Trump is cheering on their recovery, which is pivotal to his re-election message. There is also the danger of retaliation against US companies with strong ties to China, which has alarmed business.

Amy Celico, a former USTR official who focused on China and is now at Albright Stonebridge, an advisory firm in Washington, said the “gloves are off” in the US-China relationship, but that both in Congress and the administration, there was still concern that financial decoupling could backfire on the US. “It’s a little bit harder for president Trump to get on board with that, yet,” Celico said. “There are other tools he can profitably deploy that make him seem tough on China and ‘punish’ China for behaviour [the US] does not support.”

Charted waters

Earlier this month, it emerged that EU trade commissioner Phil Hogan had written to his US counterpart, Robert Lighthizer, to propose reviving negotiations with the US on ending the two sides’ trade disputes. He also proposed increasing co-operation as part of efforts to mitigate the impact of coronavirus on the global economy. That impact on trade between the US and EU is stark, as figures show that, when compared with the previous year, US imports from Europe fell even further in the first two weeks of May than they did in April. 

Person in the news

Edward Yau has attempted to reassure investors about Hong Kong’s future © Romeo Gacad/AFP/Getty

Who is it?

Edward Yau, Hong Kong’s commerce minister

Why is he in the news?

China’s plans to impose national security law on Hong Kong led to a flare-up in US-China tensions and prompted a retaliatory threat from the US to remove Hong Kong’s preferential treatment — sending Hong Kong shares tumbling this week.

In a bid to reassure investors about the city-state’s future, Yau told the Nikkei Asian Review: “One thing I can assure the international community is that Hong Kong [will] remain the same place where we uphold rule of law, freedom, and remain the most competitive and the freest [market].”

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