The US and China: Diplomacy is Back, but Will it Work?

In his sixth month of office, President Joe Biden made his first trip overseas. With a busy agenda that included the G7 and NATO summits, his intention was to re-establish the US’s diplomatic ties with its western allies following the tensions of the Trump era. However, in a stance more akin to his predecessor, he also aimed to deliver strong words to China regarding its claims to global leadership and to reassert his position as leader of the free world.

Despite Biden’s confident claim that “diplomacy is back”¹, was he successful in persuading his allies to unite behind US efforts to curtail the dominance of China? And in this highly globalised world would this even be possible, particularly as without China’s co-operation the twin fights against the pandemic and climate change would become even more challenging? Additionally, what would greater tension between the west and China mean for investors?

The headline from the Carbis Bay G7 Summit Communiqué was a determination to beat COVID-19 and plans to Build Back Better. But the messaging also focused on recognising “the particular responsibility of the largest countries and economies in upholding the rules-based international system and international law” and their intention to challenge “non-market policies and practices which undermine the fair and transparent operation of the global economy”, comments that directly alluded to China².

The G7 also called on China “to respect human rights and fundamental freedoms,”³ stressing both Xinjiang and Hong Kong. These words not only highlighted the ideological differences between the US and China – democracy versus autocracy – but also signalled Biden’s resolve to mobilise the G7 – and other sympathetic nations – to take on the might of China.

Unease about China’s growing military ambitions underpinned the NATO meeting. China has the largest naval fleet in the world and its joint military operations with Russia– has not been welcomed.

As with the G7 communiqué, NATO’s official statement delivered a stronger line against China than it has done previously, by highlighting it as a security risk and calling “on China to uphold its international commitments and to act responsibly… in keeping with its role as a major power.”⁴ That said, NATO secretary-general Jens Stoltenberg sought to minimise these words by insisting that China should not considered an ‘adversary’⁵.

China was quick to denounce both the G7 and NATO statements, calling them slanderous and attempting to diminish the power of these western institutions by stating: “The days when global decisions were dictated by a small group of countries are long gone.”

Significantly, it was reported that China’s military aircraft initiated a large incursion into Taiwan’s air defence buffer zone on 15 June. To what extent this should be interpreted as a message of China’s displeasure towards the west’s perceived interference in China’s rule (which includes its stance on Taiwan) or a timely demonstration of its military strength is uncertain. But it implied that relations between China and the west will remain strained.

Despite their obvious pleasure in meeting President Biden face to face, it was notable that the other G7 leaders were more cautious in their direct statements regarding China. The French president, Emmanuel Macron, stressed the need for Europe to maintain its “independence when it comes to our strategy to China.” While UK prime minister, Boris Johnson didn’t mention China directly during his closing statement and commented that “I don’t think anybody around the table today wants to descend into a new Cold War with China.”

Given China’s growing dominance in global trade, it is not surprising that countries were reluctant to criticise too strongly. Last year, China was quick to retaliate to Australia’s call for an independent coronavirus enquiry by halting its imports of several Australian commodities. The need to maintain cordial relations with China is also crucial for the G7’s ambitions to address both climate change and the pandemic.

China is currently the world’s largest emitter of greenhouse gases, contributing 27% of global emissions versus 11% for the US (the second largest) . Therefore, it would be futile to disregard China’s climate change contribution.

China is starting to play its part. As well as pledging to reduce emissions and reach carbon neutrality by 2060, China’s Belt and Road Initiative, which has provided infrastructure support to developing nations, has already established green projects in many emerging markets.

The G7’s commitment to ‘Build Back Better for the World’ aims to challenge China here by offering a financial and infrastructure model, underpinned by higher environmental standards and transparency. Yet, the group failed to agree how this initiative would be funded or what it would involve, currently representing little more than good intentions.

The G7’s commitment to ending the pandemic led to a pledge to issue one billion Covid vaccine doses to poor countries. While this commitment is needed, it could be argued that it has come very late and doesn’t meet the enormity of vaccines required to protect the world’s poorest countries. This hesitancy on the part of the G7 opens the door for China to step in and help fill the vaccine void with its domestically produced vaccine.

Ultimately, both climate change and the pandemic present China with an opportunity to show itself as a benign global leader – exactly the position that Biden is striving to diminish. However, co-operation and collaboration will be needed if the world is to truly make progress on these issues.

Despite some concerns over China, it is undoubtedly an important global player, and is a critical part of the global supply chain, as well as developer of new technologies. Certainly not an area for investors to ignore.

At BNP Paribas Asset Management, we believe, depending on your investment goals that given its growing weight in major global market indices and its maturing financial markets (the country now accounts for nearly 18% of global GDP and 11% of global equity market capitalisation ), China cannot be ignored in a balanced portfolio. Moreover, Chinese assets historically show a low correlation with developed and other emerging markets – providing attractive diversification qualities.

China will also play an important role in the evolution of the energy transition and associated infrastructure development, as well as the need to establish more sustainable food and water supplies given its significant population and its shift to middle-class living standards. However, investors wanting to consider the social and governance elements of ESG (Environmental, Social, and Governance) are right to be wary of China.

That’s why we include Environmental, Social, and Governance factors into the heart of our investment process and investigate all angles to make sure the companies we invest in meet our high responsible investment standards. In our view, it shouldn’t be a question of whether China features in an investors’ portfolio, but how that investment is managed.