China, U.S. partnership needs to evolve

By Vikram Barhat | March 3, 2011 | Last updated on March 3, 2011
4 min read

It’s a strange dance with partners on either side of the Pacific. The U.S. and China need each other, yet there is growing unease at the seemingly one-way flow of capital, jobs and technology in this relationship.

China’s U.S. debt holdings soared 30% according to the U.S. Treasury Department’s recently revised figures, the result of the weakening U.S. dollar against the yuan, which made assets more affordable to Chinese investors.

Beijing’s total holding of U.S. debt rose by US$268 billion from previous estimate to US$1.16 trillion in December 2010, government figures show. Although this allays financing fears in the U.S., it also fuels the perception that the U.S. is beholden to Asia’s growing economic superpower.

With China being the largest foreign debt-holder, the U.S. relies on China to keep domestic prices down. Experts in North America, already worried about an uncomfortable relationship between the two countries, fear it could worsen the cold war and lead to trade wars and currency hostility.

Agnes Deng, portfolio manager of Excel China Fund and head of Hong Kong China equities at Barings Asset Management (Asia), argues it couldn’t be father from the truth. She places the blame for this perception on ill-informed alarmism in the Western media and ignorant war-mongering noises made by some pundits in this part of the world.

“If you followed media reports of Chinese President Hu Jintao’s state visit a few years ago to the U.S., they played the wrong national anthem outside the White House when he arrived for the state dinner,” she said making a point about widespread ignorance in the U.S. about China.

In a diplomatic gaffe, a Taiwanese anthem instead greeted Hu, said Hong Kong-based Deng who stopped off in Toronto en route to the U.S. to speak to a select group of investment advisors.

“This time round the preparation was right up there in terms of quality and importance Jintao’s visit received,” she says of his January state visit to the U.S.

Deng says this diplomatic shift demonstrates the changing American attitude toward China, as the latter emerges as a global economic powerhouse.

Admitting that the financial world has become bipolar, she is quick to dismiss the cold war mindset which is growing in the West. “I think it’s a bit too early to say there is a cold war between the U.S. and China,” she says. “Protectionism [has been] on the rise in the U.S. because of its deteriorating financial situation [resulting from the] global financial crisis; that is understandable.”

She stresses the two powerhouses must keep their eyes on the “bigger picture” and develop a symbiotic relationship. “The U.S. needs China for economic support; the Chinese government buys a lot of U.S. Treasury bonds, and also invests heavily to support the U.S. economy.”

One example of bilateral trade is the $19 billion deal to purchase 200 Boeing aircraft, which came on the heels of the January state visit by Hu to the States.

It’s a give and take relationship where both stand to gain. “On the other hand, China needs help from the U.S.,” Deng says. “China is a developing [country] and needs the U.S. for its technology and education for its younger population.”

She concedes there is friction between the two countries, but stresses the primary goal of their leaders is to focus on positives and set their priorities accordingly. The U.S., she says, must be more “open-minded” about China and be more willing to cooperate.

Deng pre-empts another line of attack: the widespread Western skepticism about China’s decision to let the renminbi, or yuan, float freely.

“Renminbi appreciation is quite complicated; it’s not the matter of China alone, it impacts all of its trade partners around the world,” she says. “So you need to consider the consequences of China [appreciating its currency] too quickly and suddenly.”

Secondly, China has only just recovered from the global financial crisis, and needs its “monetary policy and fiscal policy to be as prudent as possible. If China had a financial crisis, others couldn’t remain unaffected by it,” she adds. “We live in a highly correlated world and [therefore] there’s a consensus that the appreciation of yuan should be gradual.”

A quicker appreciation of renminbi would potentially oust the dollar as a global reserve currency and impact the international currency system. “You can’t really guarantee [governments] will hold as much U.S. dollar; they’ll probably want to hold as much renminbi as possible” because of their trade ties with China.

As one of the fastest growing economies in the world China is invariably compared to its neighbour to the south-west, India, the economy of which is also growing at breakneck pace. The question many in the investment world now are asking is: China or India?

Deng has an answer but avoids simplification in favour of a more thorough approach when comparing the two. For one, she says, the two countries are at two different stages of development. Although growing fast, India’s GDP is far below that of China. India, however, with more than half of its population under the age of 25, has a demographic edge. It all finally leads to the popular India-is-where-China-was-15-years-ago conclusion.

“From the investor’s point of view, we look at the growth perspective and valuation,” explains Deng. “If the Indian market is fully priced in and the valuation in China is much cheaper, then you should choose China for valuation attractiveness.”

All things considered, for a 12-month investment horizon, Deng prefers China to India. “That is because the current valuation of the China market is much cheaper. China is currently trading at 11 times forward P/E multiple, while India is trading at 15 times.”

However, if valuations in the two countries are level, then India becomes the default choice. “At the same valuation India can deliver faster growth and higher returns on investment,” she says.

Vikram Barhat