Is an EU/China trade war next?

Andrew Macken

Montaka Global Investments

The following is an extract from a note that was recently sent to investors in the Montaka Global Fund. At Montaka, we believe there are five major forces that will significantly shape investment returns over the coming decades. One of these relates to the “New World Order” that is currently emerging. Whether it’s the uprooting of norms by President Trump, the UK’s decision to leave the EU, China’s rise as a state-dominated economy, or the increasingly brazen actions of the likes of Putin, Mohammed bin Salman, Erdogan or Kim Jong-un. An evolving world order can result in evolving risk/reward profiles for global investments. As such, we believe that analysing and understanding these global trends is of critical importance for any global investor.

Source: Montaka Global Investments 

Back in January, the Federation of German Industries (BDI) released a policy paper titled: Partner and Systemic Competitor – How Do We Deal with China’s State-Controlled Economy? This is significant given the BDI is an influential industrial federation and Germany is by far the most powerful country and economy in the EU. This paper is aimed directly at policymakers in Germany and in the EU more broadly.

The paper touches on some deep issues that truly affect the global world order. For example, the BDI observes the competition that has emerged between two economic systems: (i) the system of a liberal, open and social market economy; and (ii) China’s state-dominated economy.

“For a long time it looked as if China would gradually move towards the liberal, open market economies of the West by integrating into the world economy and reshaping its economic system.

This theory of convergence is no longer tenable. China is no longer developing structurally in the direction of a market economy and liberalism but is in the process of consolidating its own political, economic and social model. At the same time, China as an emerging economic power is shaping other markets and the international economic order.”

At the heart of this divergence in systems is the recent rise of the effective-dictatorship of President Xi. The paper highlights the recent creation of “Xi Jinping Thought” and the elimination of term limits for President Xi. Furthermore, the paper notes that: “Since taking office, Xi Jinping has questioned central political principles of the reform era established under Deng Xiaoping.”

The results of excessive state-control of the economy have included significant overcapacities in many sectors and other market distortions. These continue to have consequences for the European and global economies.

The paper acknowledges that China’s market is large and attractive but comes with challenges. For example, the BDI highlights China’s active policies to achieve technological supremacy. The BDI puts it like this:

“With the help of state investments in future technologies, direct and indirect and often non-transparent subsidies for companies, forced technology transfer and strategic takeovers of foreign high-tech companies, China is rapidly developing into a technologically leading nation.”

Furthermore, the BDI notes that while Chinese companies have enjoyed relatively free access to the EU’s internal market to date, this does not apply equally to foreign companies in China. Or said another way: “There is still a high degree of asymmetry in market access between China and the EU.”

These are many of the same issues that the Trump Administration has raised, though the BDI has taken a significantly more gentle and polite approach with its language.

Across many dimensions, Chinese leaders simply have different ideologies to those most commonly found in the West. One specific example of such differences can be observed in the area of cyber. Now, as the BDI points out:

“The Chinese leadership is working intensively to further increase the efficiency of economic planning and social control through artificial intelligence and big data processes. One example of this is the Social Credit System…” 

In a discussion with former Acting Director of the CIA, Michael Morell, former NSA Director, Mike Rogers, positioned this “dichotomy of views” on cyber relative to those held by the US. According to Rogers[1]:

The US view has always been that cyber is a “global commons” in which the broad discretionary capability of industry to develop capability resulted in a broader good for the world around us; whereas

The authoritarian states of the world believe that information and the cyber-dynamics should be viewed as an extension of a state’s ability to control its territory.

And the Chinese are no longer being shy about promoting their state-dominated economic model as an alternative approach for developing countries. For example, China’s “16+1” initiative, which includes 11 eastern EU member states and five Balkan countries, seeks to build cooperation across the dimensions of infrastructure, high technologies and green technologies. This, along with China’s well-known Belt and Road Initiative, are examples of China leveraging its political and economic weight to gain influence.

Countries party to China’s 16+1 initiative

An interesting question to ask is as follows: could the EU be about to embark on the same relationship-resetting journey that is currently being pursued by the US? Would the EU be bold enough to try? Don’t forget: the size of the Eurozone economy is just as large as the size of the Chinese economy; and its combined military budget is higher than that of China’s – and this is excluding any NATO treaty benefits from being allied with the US.

That said, the economies are heavily dependent upon each other. For example, Germany alone has approximately 5,200 companies comprising over one million employees currently active in China. And the BDI openly asserts that a general “containment” of China or “decoupling” of economic ties with China is not an option. The BDI puts it this way:

“There is a fine line between adaptation including maintaining the liberal, social and open market economy order on the one hand and a protectionist isolation of one’s own markets and intervention in the liberal economic order on the other hand. Measures taken by the current US administration indicate that protection against Chinese distortions can quickly slide into protectionism.”

The BDI has successfully outlined the long-term systemic challenges posed by China. It remains to be seen precisely how German and EU policymakers deal with these challenges. Yet, we believe it is important for global investors to analyse and understand these developments. As the global world order evolves, so too does the risk/reward profile of many global investments.

[1](CBS News) Intelligence Matters

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Andrew Macken
Chief Investment Officer
Montaka Global Investments

Andrew is responsible for managing all investments at Montaka, including the ASX-quoted Montaka Global Long Only Equities Fund (ticker: MOGL) and Montaka Global Extension Fund (ticker: MKAX).

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