Global briefing: Financial decoupling/ NATO+, BRICS, & friendshoring/ Transitory inflation?/ The geopolitics of equity markets/ New Zealand

This note is available in full at: https://davidskilling.substack.com/p/global-briefing-financial-decoupling

1. Financial decoupling

Trade decoupling with China, outside a few categories such as semiconductors, is proceeding at a very gradual pace.  Merchandise trade flows between China and Europe/US are only recently off record highs.

However, decoupling of capital flows may be happening more rapidly.  The US continues to tighten restrictions in areas relating to sensitive technologies and beyond.  In Europe, the Dutch government has just introduced new inward investment screening legislation and is now reviewing a purchase of a semiconductor firm by a Chinese-owned entity; and the Italian government is considering reviewing Sinochem’s ownership stake in Pirelli. 

This activity will be stepped up; the EU’s economic security strategy will be released later this month, which will likely contain additional restrictions on investment.

This is beginning to have an impact.  Chinese investment into the US has slowed to almost zero; and Chinese investment into Europe has also reduced (see my recent discussion).  And the big-ticket German FDI into China is largely in the form of retained earnings from Chinese operations not new capital flowing into China. 

An even more pronounced picture of capital decoupling can be seen in terms of portfolio flows, which are less sticky/more mobile than FDI.  Consider just a few examples from the past couple of weeks.

Venture capital firm Sequoia Capital split into three firms, with separate US and China firms being established – partly reflecting geopolitical constraints on investing into China.  Western investors are backing away from Chinese private markets.  And it is more difficult to undertake due diligence on Chinese firms or access economic data, which makes private Western investment more challenging.

There is also growing institutional investor demand for Asia ex-China investment products, in the way that Asia ex-Japan products were common from the 1990s.  Investors are reducing China exposure on concerns about both economic and geopolitical risk.

And despite the recent visits to China by Jamie Dimon and others, there are growing limits on the participation of Western financial institutions in the Chinese market.  Foreign banks are involved in an increasingly small share of M&A transactions in China; and this year, no US bank has been involved in a Chinese IPO.

Investment flows seem more sensitive to geopolitical tensions than most trade flows.  Capital will increasingly be allocated to ‘friendly’ markets.  This fragmentation of global capital flows will come at a cost, but reflects new geopolitical realities.