China could block Australia's exports again. Here's why that's not a big deal
I’ll let you in on a little secret. While they may not care to admit it, even the most die-hard bottom-up, fundamental investment managers follow and consider macro events.
How do I know this? Because I’ve interviewed them on The Rules of Investing. We discuss their bottom-up approach, sure, but we spend an equal amount of time discussing the stories dominating the front pages of the AFR or Wall Street Journal.
And there’s nothing wrong with that.
Investing doesn’t take place in a vacuum. It would be a dereliction of duty on their behalf to ignore macro risks. Pandemics can freeze supply chains and change consumer behaviour, wars can send input costs soaring, trade agreements change the competitive landscape. All this directly affects the companies they invest in.
One geopolitical event dwarfs all others: the economic rise of China and the threat it poses to US hegemony.
This is hugely important for Aussie investors, especially those invested in foreign markets, because Australia is caught right in the middle of the crossfire. China is our largest two-way trading partner in goods and services, while the United States is our most important national security ally.
In this wire, I’ll take you through:
- China’s economic ambitions, and the risks and opportunities this poses for Australia’s economy;
- how China has weaponised trade (and how Australia has responded); and
the outlook for Australia’s export sector
What does China want?
According to Dr Naoise McDonagh from the University of Adelaide, China wants to embed a hub-and-spoke model of regional trade and investment flows centred on China, serving both geostrategic and economic ends.
It does this through trade and institution-building.
"China fosters centrality through targeted free trade agreements with regional partners, and the ASEAN block, while also engaging institution-building, such as the Asian Infrastructure Investment Bank (AIIB) or participating in the RCEP trade agreement," says McDonagh.
"International institutions are the governance glue that create and maintain global or regional order."
Being the lead author and champion of these institutions has other perks, too.
"Another benefit is that the lead country gets to become akin to a referee who makes and enforces economic rules for others, while also competing."
China’s regional centrality poses a clear set of risks and challenges for Australia. This can be seen in the recent diplomatic manoeuvring by China, the US and Australia in Papua New Guinea - an economic minnow that happens to strategically straddle trade routes beyond the so-called "Second Island Chain."
"An already asymmetric trade relationship risks becoming even more asymmetric, leaving Canberra more vulnerable to economic coercion. The latter is a tactic Beijing engages in regularly to achieve political ends. Likewise, the more Beijing leads the creation of major regional institutions, the more China sets the rules of the regional economy."
Trade has become one of the main tools China uses to get what it wants economically but also politically.
"Beijing has made it very clear, and not just to Australia, that political behaviour which displeases the Party will lead to consequences. A main lever for apply such consequences is economic coercion, since aside from the U.S. and EU, China always has an asymmetric advantage in bilateral trade relations."
So how does it do this? By targeting politically sensitive exports that are heavily concentrated on China.
China yanked that lever after Australia led international calls for an inquiry into the origins of the COVID-19 pandemic.
Just a week later, China threatened consumer boycotts of Australia. Then, in May 2020, it made good on its threats by imposing anti-dumping duties on Australian barley. Soon after, Australian beef producers were stripped of their export license. Then they applied duties to wine, customs bans on lobsters, wheat, lobster, timber, copper, sugar and even table grapes.
Chinese utilities companies were also discouraged from purchasing Australian LNG from the spot market.
Highlighting the connection between trade and geopolitics, China accompanied its trade measures with a list of "14 grievances" which Australia had to rectify in order to normalise relations.
You might think that this would decimate Australia's export market. But you'd be wrong.
According to Australian Treasury estimates, sectors affected by Chinese trade restrictions lost $5.4 billion in exports to China. But the net loss was only $1 billion - just 0.25% of Australia's exports.
So how did a $5.4 billion hit net out to $1 billion in damage?
China's shots fell short of the target because of the magic of markets. Specifically, trade diversion.
It was an old fashioned game of musical chairs.
"After China cut off Australian coal, the price of coal in China’s domestic market moved higher due to temporarily restricted supply," says McDonagh.
"This in turn incentivised Indonesian coal exporters selling into the Indian market to divert to China to take advantage of the higher price. This in turn left a gap in the Indian import market, which Australian coal exporters began to fill, at a discounted price to what they could get in China, but still selling at a profit."
The same thing played out in other markets, too.
Barley went to Saudi Arabia and Southeast Asia, copper went to Bangladesh and Vietnam, and copper found buyers in Europe and Japan.
"China's bark is worse than its bite," is the takeaway according to Jeffrey Wilson, research director of the Perth USAsia Centre.
"China may be a large and important economic partner, but it is far from the only one out there. International markets rearrange themselves to adapt to sanctions, greatly reducing their actual impact."
Outlook for Aussie exporters
Australia's trade relations have improved with China since the "14 grievances."
"First, Beijing has decided it is willing to thaw the diplomatic freeze now that a new federal government is in place, meaning a further escalation of economic coercion is unlikely, absent major new direct provocation. Second, the Albanese government has indicated it is willing to engage constructively with this upturn in bilateral relations, while ensuring Australian national interests will not be compromised."
This doesn't mean China won't again weaponise trade against Australia.
"The reality is that Australia exporters will have to learn to live with Damocles Sword hanging over their China trade for the foreseeable future," says McDonagh.
"When that occurs, firms had better have a geopolitical risk plan at hand to reallocate, divert or transform according to whichever strategy best suits their specific product."
For some great analysis on the investment case for China vs Australia, head over to this great article from my colleague Hans Lee .
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David is a content editor at Livewire Markets. He currently hosts The Rules of Investing, a half hour podcast where he sits down with leading experts across equities, fixed income and macro.