Kristen Hallam

I'm Kristen Hallam, content strategist at S&P Global Market Intelligence, and your host for this episode. Trade between the U.S. and China reached a record in 2022 with imports and exports between the countries exceeding $690 billion. What are the forces shaping the economic relations between the 2 countries? And what can we expect on U.S.-China trade going forward?

Here with me to discuss these questions are John Raines, Director at S&P Global Market Intelligence; and Todd Lee, Chief China Economist at S&P Global Market Intelligence. Thank you both for joining me today.

Question and Answer

Kristen Hallam

So let's dive in. How dependent are the world's 2 biggest economies on each other?

John Raines

They're pretty dependent, aren't they? If you try to go out right now and you want to buy a toaster or a stroller, maybe a video game console, I mean, good luck trying to find whether it's not made in China. And it makes sense, right? China has become the world's factory for a reason. We have 5 decades really of manufacturing know-how in regard to a decent infrastructure. You have reliable production. Currency is relatively stable, as well as the economic climate and also you have a domestic market there that you can sell into. So it's not surprising that last year alone that 20% of all imports for the U.S. ended up coming from China, right?

And of course, we have that trade deficit. We try to -- again, none of that is surprising. But I think in some ways, that's really only half of the story. Because I think in some ways, yes, the U.S. is dependent on China, but maybe it's becoming a little less dependent over time. And obviously, due to COVID, due to the trade war that occurred, due to the fact that we have all of these different interests that are out there and due to supply chain shocks that we saw over the last few years, we're starting to see investment beginning to shift, and not necessarily for folks actually leaving China per se, but really looking for -- if they are looking to expand their manufacturing operations, maybe they look towards Asia, maybe they look towards coming back to the United States or maybe Mexico.

So I do think that we're starting to see a shift here, but at this particular juncture, pretty clear, there's a codependency there.

Todd Lee

I believe John, and I just want to add that the focus on U.S.-China economic relationship is mostly on trade, but that's not really the full picture. The commercial ties between the 2 countries. John already alluded to some of it. But if you look at [ Hutch ], the U.S. business operating in China, there's a lot of them in China making money. And these U.S. firms in China, their sales is close to $400 billion per year, much larger than the Chinese companies' in-country sales in the U.S.

So it's sort of a mirror image of the trade picture. Now we combine this in-country sales with exports, the so-called combined revenue, if you will, is about the same between the 2 countries, more than $500 billion per year for each side. So the U.S.-China commercial ties are immense, as John mentioned, and they're far from one-sided.

Kristen Hallam

Those are just some really big numbers you just shared with us there, Todd. I'd like to take an opportunity to just go back in time a little bit and give our listeners maybe a mini history lesson about how we got here in terms of the current trade conflict between the 2 countries. John, can you take us back in time in your trade time machine there.

John Raines

Yes. I think in some ways, to understand where we are today, I think what's most relevant is actually realizing almost where we were because it's really a 180 that we've taken as far as U.S.-Chinese economic relations. I mean you look in the 1980s, right, so China is opening up. Now we have the normalization of ties between the United States and China. We have trade increasing 45x from 1980 to 2004. That was from $5 billion to $230 billion. I mean dramatic increase.

But I think what ends happening is that as we start to see this Chinese economy grow, we're starting to see fears inside the United States that soon, China is going to be the largest economy in the world. It's going to be a rival to the U.S. And so it's not surprising that we start seeing under Bush with some steel tariffs. And then we start seeing under Obama, we had tire tariffs and we had to buy American provisions. And of course, we have the advancement of this TPP trade initiative that would actually bring in other regional partners in Asia aside from China as a possibility, then we're starting to begin to understand that really this relationship is starting to go in a different direction.

And of course, under Donald Trump things take a huge turn. Donald Trump has been talking about unfair trade practices since the 1980s against Japan. So it's not surprising that he would do it. We start to see new tariffs on textiles, on electronics, on aluminum, on steel, you name it. And some of these go up to 25%. And then on top of that, we start to see some export restrictions on some of the largest companies in China. And of course, the Chinese are going to respond at times. So we're starting to see China beginning to raise tariffs on U.S. goods as well.

So this goes on for a while. It's a kind of a tit-for-tat battle. And at the end of the day, that brings us to the phase 1 trade agreement, which again lowers some tariffs. And again, there was this expectation that China would dramatically increase its purchases of U.S. goods. And really, at the end of the day, neither side totally kept up their side of the bargain. And so with that in mind, that gets us to where we are today.

Kristen Hallam

Interesting. And have we seen any impact on the U.S. economy. If they're not getting certain products from China, has that been stimulating domestic manufacturing in the U.S.? Any particular impacts we're seeing there?

Todd Lee

Well, first of all, the tariffs didn't really achieve the desired effects because the U.S. deficit with China actually rose since the trade war rather than shrink. And also U.S.' overall deficit grows as well. So this has to do with the low savings of the U.S. So that's a structural problem rather than a bilateral trade problem that cannot be solved and addressed by tariffs.

In terms of these tariffs' impact on the U.S. economy, most economic research found that the tariffs mostly passed through to the U.S., meaning that these import duties were mostly pushed to the U.S. buyers rather than being absorbed by Chinese suppliers. So some of them passed through into U.S. firms' margins. Some filtered to prices. Some were circumvented by U.S. able to source from other countries. And some were offset by the strong U.S. dollar. But that was triggered by the very aggressive U.S. rate hikes to combat the U.S. inflation. So although these tariffs were not the cause of surging U.S. inflation, but they certainly are not helping.

Kristen Hallam

I want to touch on something you've both mentioned, which is this diversification of sourcing data from peers, which is an offering of S&P Global Market Intelligence, tells us that in 2022, the share of U.S. imports from China dipped to the lowest level since 2006. So I'm wondering could diversification of sourcing, whether you want to call it reshoring, nearshoring, friendshoring, could that be driving what we're seeing from the data there in terms of the share of U.S. imports from China going down? And what movement, if any, have we seen by Chinese companies to diversify their supply chains as well?

Todd Lee

There's some evidence of friendshoring or even nearshoring because for the products that U.S. imposed tariffs on during the trade war, U.S. are importing much more from countries outside China, but they are also anecdotes of Chinese firms setting up shops in countries like Vietnam, even Mexico, right, to spur the U.S. tariffs. So this is kind of a friendshoring in disguise. So some of the friendshoring is actually China -- U.S. is still buying from Chinese firms.

But in terms of reshoring, there's just no general evidence of that. There may be some adhoc cases here or there. And the reason that reshoring is really challenging is because the products are being imported into the U.S. The U.S. is doing that because they are too expensive or more expensive to be producing in the U.S. than elsewhere to begin with, right? So there's no business or economic rationale to bring back production of these products domestically unless there's a huge political premium in them -- so a risk premium for companies to do that. But there's no commercial rationale for that to happen.

John Raines

I just totally agree with Todd there. I mean it's just very difficult when you're a manufacturer and you're looking at China where I think the average wage is about $6 an hour, and you're coming to the United States and you're paying $20, $25 an hour or more, right? It's just not going to be profitable long term to be in that environment when you have other options available to you.

Now we have seen instances where we've seen new investment, right? So when it comes to semiconductors, major plants being planned in Ohio, in Arizona, in New York and elsewhere. So I'm not saying that it isn't happening, but it's certainly not happening in a way that I think maybe Donald Trump or maybe even Joe Biden hoped it might happen when they initiated and then followed through on some of these policies.

What we have seen, and you brought this up, Kristen, is really that friendshoring or nearshoring argument start to take hold for certain firms out there. For example, like when we look at Mexico, we are seeing some significant levels of investment into the country. If for no other reason, then you have proximity, you're just across the border. Mexico, free trade agreement with USMCA and of course, low labor price. In fact, for some industries, actually lower than what we see in China.

So it's not surprising that we're starting to see major investments in Baja California, German firms, French firms, South Korean firms there, as well as Nuevo León, right, where 30% of the investment there is not necessarily coming from the United States, but that's actually Chinese firms that are locating in industrial areas inside the state and they're saying, this is a great opportunity for us to manufacture our products, especially if we can send them to the United States duty-free. Why wouldn't you do it?

A lot of people don't know this, but 80% of the foreign leased industrial parks in Mexico are now being leased by Chinese-based companies, right? So it's not surprising that everyone sees this as an opportunity and they're following suit. And then again, China is doing it. Like I said, the French are doing it. And the U.S. is doing it, too. We're starting to see increased manufacturing, semiconductors, automotive parts, metal equipment, all of that going to Mexico as an opportunity to take advantage of those lower costs.

And again, I don't think this is going to change anytime soon because with the legislation that we've seen in the United States, whether it's the Bipartisan Infrastructure bill, the CHIPS Act and then, of course, now most recently, the IRA, the Inflation Reduction Act, a lot of that production is going to have to go someplace, that legislation has specific guarantees for places like Mexico, like Canada and other locations that have free trade agreements with the United States.

So yes, I do think you're starting to see it with that nearshoring. I do think you're also seeing a bit, I should say, just in passing, really with friendshoring. So we are seeing isolated examples of individuals beginning to maybe not necessarily take manufacturing out of China directly. But when they're looking at new plants, they start looking at Vietnam, they start looking at Malaysia, Indonesia and then also India.

Kristen Hallam

Lots to unpack there. So given the interdependence of these 2 economies, the world's 2 biggest economies, something that's been talked about is decoupling. Is that realistic, given what you 2 have shared on our podcast today? Todd?

Todd Lee

It's not realistic, at least over the medium term. I mean a swift and complete decoupling between these 2 economies will cause immense economic pain, given the size of their commercial ties we already discussed. It will also cause immense pain for the global economy in which will ricochet back to the U.S. and China. And not just because U.S. and China are the 2 largest economies in the world, but also the complexity of the global supply chain that incidentally U.S. led to build, right, and how deeply and widely China is embedded in that supply chain.

So to sever U.S. and China ties in that global supply chain will cause tremendous disruption to the supply chain. Just look at the economic pain Europe has suffered from decoupling with Russia. The relationship there is much more straightforward and mostly revolve around energy. So a complete decoupling between U.S. and China and what the exact pain is many, many times larger.

John Raines

Yes, I agree. I think the possibility of them fully decoupling is virtually impossible at this point. There are a couple that are pretty much codependent on each other, and there's really no way out of this relationship. I don't think anyone really believes that we're going to see an economic divorce anytime soon, but I do worry about the possibility that maybe these 2 actually do need some marital counseling. That might actually help them a bit.

Kristen Hallam

While we're talking about separations, something else I wanted to ask you about was dedollarization, which is something else that gets talked about. Dedollarization, substituting the U.S. dollar as the currency of trade in oil and other commodities, just generally reducing the dollar's dominance in global markets. Is that realistic?

Todd Lee

It's also not realistic, at least over the medium term, if not a long term. And the key issue or the obstacle for the Chinese renminbi to become a major global reserve currency and supplant the U.S. dollar is China's capital control, meaning that the renminbi cannot move freely in and out of China. That could paralyze China's financial system and debilitate its economy.

Kristen Hallam

Do you see this lingering around as an issue, the dedollarization? Is it something that we're going to be talking about 5 years from now or 10 years from now?

Todd Lee

It will get talked about because it's the hot button issue and because of size of China's economy. And they're trying to do things on the edges, like cleaning up these international payments system in parallel to Swift, but the size is much smaller. And for these structural issues, they haven't really been able to make much gains in these efforts. So you may see some sort of peripheral achievements that they're making or gains that they're making, but they don't really fundamentally change the picture.

Kristen Hallam

Let's go to the lightning round. And what would be your top takeaways for our listeners today. Todd, I'll start with you.

Todd Lee

I'm going to borrow the marriage counseling analogy that John used because while the U.S.-China economic ties are fraying because of geopolitical and trade tensions, but given the breadth and depth of the bilateral commercial reliance and plus these 2 economic giants, the central and commercial role in the global economy, breaking up between the American and Chinese economies is really hard to do. So that's my main takeaway. Breaking up is hard to do.

Kristen Hallam

John, how about you? What's your top takeaway from our discussion today?

John Raines

Yes, maybe breaking up is hard to do is mine as well. At the end of the day, both sides realize they can only take this relationship so far. I keep talking about the idea of it's almost like limbo. How low can these relations go before they break. And what we're finding is they can go pretty low, right?

It's very difficult for them at the end of the day because of this dependency that they have on one another that, at the end of the day, they're still going to have to talk to one another, whether it's on the issues of what's going on in Ukraine, whether it's on issues of climate change, whether it's on issues that really affect the entire globe. They're going to have to deal with one another, but it's not necessarily going to be a pretty picture any time soon.

Kristen Hallam

And on that note, thank you both for your time today, for sharing your insights. And please subscribe to the podcast, where we will be diving deeper into the issues shaping the geopolitical and economic outlook for 2023.