The policy contours of the next administration are still evolving, but the US and Russia appear to be on the cusp of another period of glasnost, while US gestures towards China have been anything but sweet.
US president-elect Donald Trump has already challenged China over Taiwan and the management of its currency, and he threatens to slap tariffs on Chinese goods. Pushing back, Beijing has hinted at measures that would restrict market access to US companies in one of the world’s largest economies.
The risks to this backdrop are twofold: one macro, one micro. First, an escalation of US-Sino trade tensions represents one of the biggest macro risks to the global economy in 2017. A trade war would subdue global growth and throw sand in the gears of globalisation, while triggering volatility across asset classes. That is not our base case but ranks high on our “what keeps us awake at night” list.
The micro risk is equally unsettling. The shifting US policy stance towards Russia over China presents asymmetric risks to corporate America. Of the two dance partners, US financial linkages with China are far thicker than those with Russia.
To this point, China, a relatively poor nation at the height of the cold war, is now one of the largest economies in the world, with a nominal gross domestic product more than eight times larger than Russia’s.
Russia’s per capita income is slightly ahead of the mainland, but China’s massive population base is roughly 10 times the size of Russia’s. The number of millennials in Russia (40m) are a fraction of China’s — numbering more than 400m.
Millennials help drive consumer spending, with personal consumption expenditures in China almost six times larger than Russia’s. Internet penetration in Russia is greater than in China, but the number of internet users in the latter (more than 700m) is simply staggering. Given this massive pool of netizens, it is little wonder that ecommerce sales in China were in excess of $600bn in 2015 versus roughly $20bn in Russia.
The same gulf is evident in more traditional sectors such as automobiles. Vehicle sales of 25m in China in 2015 were more than 15 times greater than comparable sales in Russia. Whether it is spending by millennials, ecommerce sales or vehicle purchases, the market importance of China is exponential relative to Russia.
US trade already reflects this dynamic. Total US exports of goods and services to Russia were less than 8 per cent of total exports to China in 2015. The US exports more goods to China each month ($9.7bn on a monthly average) than it exports to Russia in an entire year ($7.1bn).
Like trade, US-Sino capital linkages are critical to both partners. As one of America’s largest foreign creditors, China held some $1.1tn in US Treasuries as of October 2016. Russian Treasury holdings are much smaller ($75bn). The upshot: China’s influence in US credit markets is substantial, Russia’s nominal.
Finally, America’s foreign direct investment stakes in Russia are minuscule but in China, where US companies have spent decades painstakingly building out a local presence, America’s corporate footprint is quite sizeable. One example: based on total assets, the US foreign direct investment position in China is more than five times larger than the US’s position in Russia. In 2015 alone, what US affiliates earned in China (nearly $10bn in foreign affiliate income) was more than 15 times larger than what affiliates earned in Russia. The result is that China’s influence on corporate America’s bottom line is far greater than Russia’s.
Yet US-Sino relations are entering a rocky period, while a honeymoon is developing between Mr Trump and his Russian counterpart, Vladimir Putin. Not fully recognised by investors, US policies are titling towards the more commercially unattractive Russia versus better-looking China. As already mentioned, this policy stance carries asymmetric risks for corporate America, bearing directly not only on the future earnings of many US companies but also on the pricing of asset classes, ranging from currencies to credit to commodities.
If US-Sino relations sour, at risk are US technology companies dependent on Chinese consumers and workers to drive earnings. Also in the crosshairs are US brand leaders in footwear, automobiles, consumer staples, industrial supplies and heathcare. US farm and energy interests would be affected, triggering commodity price volatility. Global currency volatility would rise, while bilateral merger and acquisition deals and real estate transactions would dwindle, altering global capital flows.
Coddling the bear while poking the dragon — it is a combination for market uncertainty and downside surprises.
Joseph Quinlan is head of market and thematic strategy at Merrill Lynch/US Trust
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