China U.S. Relations – There’s only one way this ends

By David Nelson, CFA
US-China relations are once again center stage, as a congressional hearing Thursday highlighted the deepening concern that China’s reach into our society isn’t only harmful but a threat to national security.

1-TIK TOK CEOSitting before members of the House, TikTok CEO Shou Zi Chew was grilled for hours by both Republicans and Democrats attempting to drill down on Chinese government influence over the company and its ability to protect data.
House Energy Committee Chair Cathy McMorris, Republican from Washington; Her question probably sums it up best. “Can you state with 100% certainty that the Chinese government couldn’t use Tik Tok or its parent-based company ByteDance to surveil Americans or manipulate the content Americans see?
Bottom line. Mr. Chu went into a long-winded answer about being committed to firewall in US data, but when finished, Mrs. Rogers said, “if you can’t say it’s 100% certain, I’ll take that as a no.”
Just a few years ago, there were few in Congress or America that really understood how deep China had dug into the American economy and our most prized institutions. Today, it’s common knowledge. COVID and a million lost lives later, along with images of now emperor for life, Xi Jinping partnering with Russian President Putin have pushed the US-China relations to the brink. There’s only one way this ends.
Years ago, speaking frequently about Chinese theft of intellectual property, I found only a handful of journalists and news anchors that understood the depth of the problem. Even on my personal Facebook page, friends often criticized what they called my alarmist commentary.
The prevailing theme back then was that eventually China would overtake the US economy, but that the two could coexist in a competitive but profitable relationship.

Emperor for life

3- PRESIDENT XIMaybe that was true 25 years ago, but since 2012, President Xi has consolidated power and can rule the country as long as he desires. The rules changed. The limit of serving just two 5-year terms, that’s gone.
As evidence mounts of intellectual property theft and infiltration into our universities, along with other centers of influence, America’s view of China has changed. According to Gallup polls, a record low 15% of Americans view China favorably.
Americans want answers, and not just on the origins of COVID. It appears all but certain at a minimum there was a leak at a bioweapons facility and at worst, something more sinister. And what was the role, if any, regarding U.S. funding?

Trojan Horse 

1.1 million Americans died. It ravaged the world economy. Chinese blocking of access to information borders on the criminal and morally sets them apart from the rest of the developed world.

To be clear, they played us like a violin. China’s entry into the World Trade Organization in 2001 was a Trojan horse.

ource Statistica

The carrot of US companies gaining access to the Chinese consumer has always kept U.S. investment in China high, yet last year we still had over $382 billion trade deficit with China.

The World Bank is still lending to them! This is the second largest economy on the planet with $trillions in foreign reserves, but we’re still subsidizing China.

Washington fights back

Thankfully, at least some of what I’m speaking to isn’t being lost on Washington. Senator Joe Manchin is joining GOP senators regarding a bill that would ban China from receiving more World Bank funding.

China J31 Strike Fighter vs Lockheed Martin F-35

As for intellectual property theft, it cuts right down to our most sensitive military assets. Look at a Chinese J-31 Strike Fighter. Familiar? Well, it should be. It looks an awful lot like a Lockheed Martin F-35.

2017 China National Intelligence Law

In the end, it doesn’t matter what assurances TiKTok’s CEO gives Washington lawmakers. In 2017, China put in place a new national intelligence law that states any organization and citizen shall support and cooperate in national intelligence work. All in, Chinese companies are required by law to cooperate with the CCP regarding any request.

Basically, our vendors are spies for the Chinese Communist Party. Look, I get it. They make great products, and who wants to live in a world where you can’t coexist with your neighbors? Unfortunately, that ship has sailed.

China is an adversary in every sense and will continue to challenge us on a range of issues. Foreign policy, trade and given what we’ve seen recently in and around the Taiwan Straits, at some point militarily. Today we have a bipartisan effort to challenge China and recognize them as the threat they truly are.

It cuts both ways

Remember, it cuts both ways. China has restricted or outright banned US companies for years. As far back as 2010 Google had to pull its search engine from China because of strict government censorship online.

In 2009, Facebook refused to release protester identities to Chinese officials and was blocked and remains blocked today. Twitter is also shut off but many citizens get around the law using VPNs or virtual private networks.

The Moral Hazard

Beyond intellectual property theft, the continued effort to infiltrate centers of influence and obvious acts of espionage, there is also the moral hazard. China’s record on human rights abuses should give anyone with a conscience pause.

Representative Mike Gallagher, Republican from Wisconsin and chairman of the House Select Committee on China, points out that religious minorities are rounded up in concentration camps and subjected to forced labor. 

Many human rights organizations have called out China regarding the harsh treatment of more than a million Uyghurs in the Xinjiang region, some even calling it genocide.

I haven’t even mentioned the spy balloon incident that occurred earlier this year. I’m not sure we can even call it a spy balloon. It was hardly stealth. It just waltzed across the United States for the better part of a week before it was shot down, off the coast of South Carolina. Hiding in plain sight it drifted over some of our most sensitive military installations.

The point is, effectively, there is no common ground with China and little we can share that in some way doesn’t put our own interests at risk.

Economic Divorce

Divorce, it’s tough. Everyone loses and this one will be especially painful. I said earlier there was only one way this is going to end. We are already in the early stages of a decoupling of our economies, essentially an economic divorce.

Semiconductors are Ground Zero

Look no further than the semiconductor industry. Recognizing the peril of a Chinese invasion of Taiwan, the United States is now in an all-out effort to move critical supply chains out of the region and back to U.S. soil.

Taiwan Semiconductor Customer and Supply Chain

Bloomberg Data

Some of our most advanced designs, including chips created by A.I. technology giant NVIDIA, are manufactured by Taiwan Semiconductor. If China ever seized the island, they could turn the United States on and off like a light switch.

Shooting War

We have two choices. Either we gear up and make the investments necessary to make the chips here, or we’ll be in a shooting war at some point within the next few years.

If you ask the average American if they would support a US defense of Taiwan pitting U.S. military assets against the Chinese, most would probably say no.

Don’t ask them now. Ask them when they lose access to technology they use each and every day, or we start to completely fall behind the rest of the world. Trust me, you’re going to get a very different answer.

Like I said, divorce is painful. Already some of our largest corporations recognize that there is a real danger of continuing to rely on China for their manufacturing needs.

Apple’s Tim Cook recognizes that the world is shifting under his feet. Moving some of their manufacturing to India is an important first step for them to diversify their manufacturing footprint. Unfortunately, these changes take time, and in the case of semiconductors, could take more than a decade.
As for the big picture, China aligning itself with clear enemies of the United States highlights the need for a full reset and firm commitment to what will be a very long and painful process.
President Xi thinks in terms of decades. He can afford to. Unfortunately, our leaders think in terms of an election cycle.
*At the time of this article some funds managed by David were long NVDA , META & AAPL