The importance of our relationship with China

Not a week passes without hearing more about the increasing tensions in our relationship with China. But why have things hit rock bottom, and what does it mean for Australia's future?

The challenge from China.

China is Australia's main trading partner, which in itself makes it an important relationship that needs to be nurtured. On top of that, if JP Morgan's CEO Jamie Dimon is correct, China is likely to overtake the United States within the next twenty years as the world's biggest economy and financial market. If that's the case, it's even more important for Australia to proceed with care when it comes to managing its relationship with the world's future superpower.

A strong economic recovery.

At this point in time, China is an emerging market, which means it's in the midst of a transition from a low income, less developed economy to a modern, global industrial economy with a significantly higher standard of living. As the global economy starts to bounce back from the first year of COVID-19, China's recovery has been far quicker than other developed markets. Unlike every other major economy, China's GDP grew throughout 2020, with a 6.5% year-over-year increase reported in the final quarter of the year.

The power of emerging markets.

It's undeniable that China is showing some pretty impressive results. Particularly as the International Monetary Fund (IMF) anticipate, advanced economies are likely to only achieve 4.3% growth this year. However, at this point in time, emerging markets do have a distinct advantage, not least because of their manufacturing bases, which have proved resilient as goods have been traded on online platforms throughout lockdowns.

At the same time, last year's weaker US dollar loosened financial conditions for emerging markets, resulting in a lift in activity in the energy and financial sector. And with China getting back to work earlier than other economies, it has laid the groundwork for its manufacturing and commodities industries to increase their market share.

This is all excellent news for China. But how does their bounce back benefit Australia? Mainly it's because their increased production means a stronger demand for our iron ore, coal and liquefied natural gas.

Ongoing trade disputes.

Our relationship with China has always been mutually beneficial. However, since Australia backed an inquiry into the origins of COVID-19, China has imposed hefty restrictions on all sorts of Australian imports. The list includes barley, coal, cotton, lobster, meat, timber, and wine – a clear indication of a relationship on a downwards trajectory. Canberra, however, hasn't taken these restrictions lying down, responding by introducing tariffs of their own on China's exports of aluminium, paper, and steel. And more recently tearing up some agreements that our states had with China regarding their Belt and Road Initiative.

Troubled times.

Relations have deteriorated for other reasons too. Diplomatic tensions are currently taking place, the likes of which we've not seen in decades. Several journalists have been arrested or expelled in recent months, while earlier this year, Chinese news anchor and Australian citizen Cheng Lei was arrested on suspicion of leaking state secrets. And then there's the growing risk that we could get dragged into a war with China over Taiwan.

How reliant are we on China?

In the meantime, our trade in iron ore and natural gas, which are essential commodities for China, continue unaffected. And if recent government figures are anything to go by, the current sanctions haven't hurt the Aussie economy quite yet.

How our relationship weathers the storm over the coming months remains to be seen. But one thing is clear. If China is on track to become the world's next superpower, a long-lasting feud won't help Australia's future economic growth in any shape or form.

At Clearwater, we rely on our emerging markets specialist Northcape, to navigate situations such as this. Northcape uses its expertise to determine an appropriate allocation to China and our Australian managers determine which companies to invest in, or avoid, as part of their ongoing investment strategy.

by Gary Lucas.