The Impact of U.S./China Decoupling

April 26, 2025, Hong Kong, S.A.R.

Let us take a look at the recent market conditions before discussing the impact of a U.S./China decoupling. First of all, the prediction that I made for the U.S. equity market in my March 11, 2025 blog came true, unfortunately: I predicted a range of 4700 – 5250 for SPX in the near future after March 11, and the index reached a low of 4835 intraday on April 9, the day after the “liberation day”. My prediction in my April 5, 2025 blog for SPX was 4000 – 4500 in the near future after that day, and it has not reached that level yet, fortunately. My current view is that this range of 4000 – 4500 is too pessimistic, even though the U.S. economy is indeed facing strong headwinds due to both the overvaluation of its equity market entering the year of 2025 and the negative impact of tariffs, the latter of which will surely play out in economic numbers in the next several months. The “shock-and-awe” of the Trump administration on drastically altering the U.S. domestic and international economic and political policies has apparently run into the wall of resistance, and the resistance is building. However, the domestic support for the Trump administration is still formidable. After all, the fundamental issues facing the U.S. – high government debts and significant social inequality, to just name two – still exist. Therefore, I adjust my prediction for SPX in the next several months to be 4700 – 5250, the same as my prediction made in the March 11 blog. In other words, volatility of the index will remain high but not at the elevated level following April 2, the “liberation day”, and I agree with many pundits on the Street that the recovery of the U.S. equity market will be more an “L”, instead of a “V”.

The trade war between the U.S. and China is still raging, although the tones from both sides have been turned down a little bit recently. The decoupling between these two largest economies in the world is happening in front of our faces, and there is no way back. By all means, this decoupling is first sought after by the U.S., for more complicated reasons than just the trade issue. It is inevitable in the sense that China is bound to rise as a global power that is competitive enough to the U.S., and the U.S. definitely have not found the way to accept and manage that. To the U.S., this relative (to China) decline in power is considered to be due to both internal and external factors, thus the “shock-and-awe” actions from the Trump administration. The elites of the U.S. fear China’s capabilities in uniting the Chinese people to reach near- and long-term goals, and they want those in the U.S., too. (I discussed this a little bit in my January 28, 2025 blog; see points 8 & 10 there.) That is why many people in the U.S. believe the U.S. is quickly becoming authoritarian, and rightly so. China, on the other hand, had been expecting and getting ready for the Trump 2.0 tariffs. In many ways, China are reacting to this new reality, but I expect to see more assertive actions, esp. when the two sides need to set new world orders. In other words, it likely won’t be the U.S. to decide the new orders; China will do theirs, too. There are many fronts that the two global powers will clash, and I want to point out five of the most important ones, at least in my view:

First, manufacturing: The U.S. want to have more manufacturing capabilities, and China have many. The end results (esp. in the near term such as a few years from now) will likely be that the U.S. will start (or resume) manufacturing goods that are deemed strategically important to the U.S. For non-strategic goods, the U.S. likely will still import from other countries, including China. China will continue solidifying non-U.S. markets for Chinese manufactured goods. How successful China can be in terms of enhancing businesses with traditional U.S. allies remains to be seen, as that will not depend just on goods themselves, but also on geopolitical re-arrangements.

Secondly, payment system: The U.S. dominates global payment system, and the U.S. dollar remains the global reserve currency, at least for the foreseeable future. I agree with the idea that China may not be so willing to make the RMB the global reserve currency, because the country still wants to dominate (or at least stay at the forefront of) global manufacturing capabilities, and this means that they won’t (or are not willing to) see large capital account surplus, which goes hand in hand with large trade deficits. This has many implications, esp. for other economies when they need to decide which currency (or a basket of currencies) to use in global trades. As a result, capital investments will likely to be fragmented with higher entry barriers to regional capital markets than as of now, which also means that the flow of capital will likely be more difficult than now. This will introduce more volatility into capital markets, and risk premium will be higher going forward. The needs for regional financial centers will be more, which bodes well for cities such as Singapore, Tokyo and Hong Kong for the Asia-Pacific region. Hong Kong has a unique role in this, because of its location, its existing systems, and its established function as a gateway to Chinese markets. Also, for the near term, the entry barrier to and frictions with U.S. dollar-dominated global payment system (a.k.a., the current one) for the RMB will be an issue for China, until China is willing and take actions to make RMB gradually dominate the U.S. dollar to become the global reserve currency. This, of course, also has positive impact on the price of gold. Bitcoin can benefit from this process, too. However, given the relatively concentrated holdings of bitcoin by selected institutions (esp. U.S.-based institutions), it is unlikely that bitcoin can replace gold or assume the role of “digital gold”.

Thirdly, technology advancements: This is an area that China seems to have an edge against the U.S. At least for the near term, China will quickly advance its technology developments in AI, robotics, material sciences, quantum computing, etc., and many if not all these areas may even surpass those in the U.S. The infighting in the U.S. between different interest groups will further hinder developments in scientific research and technologies, including the loss of talents from the U.S. However, it is reasonable to assume that the U.S. will likely correct these misbehaviors; therefore, the assumption of significant damages on this front to the U.S. may not be valid, at least may not have too long a shelf life.

Fourthly, services: Domestically, services account for more than half of the U.S. GDP, and the services export from the U.S. to China is on the order of 40-50 billons dollars per year, with Education as the top sector of services exports. It is worth noting that services exports to China are indeed the benefits of globalization spearheaded by the U.S., where at least higher education is currently under attack by the Trump administration as well. Many Americans believe that globalization caused the significant economic inequality in the U.S. To certain degree, the Trump administration’s recent policies represent those underlying domestic judgements by certain (not all, of course) Americans. It is worth noting that China – since the trade war during the first Trump administration – have been trying to become less reliant on services exported from the U.S. However, this may become a card in China’s hands when they need the CEOs of large U.S. corporates who have services businesses in China to influence U.S. government policies toward global trade. Therefore, one should never count out the services sector in contemplating the end results in the U.S. – China decoupling process.

Last but not least, soft power: This has been a golden card in the U.S.’s hands until recently. Much of the rhetoric of the current Trump administration toward traditional U.S. allies may have damaged U.S.’s soft power projection. I think many Americans still believe that the U.S. need soft power; the question is how much. The potential issue with soft power is that it is hard to build, but quick to lose. It is perhaps such a high maintenance cost that the U.S. do not want to accept any longer. Then, the question for China is: should China acquire more soft power? It is still hard to tell if China want to acquire the same amount of soft power that the U.S. acquired until recently. The answer may become clearer when people from both sides start to realize the importance of soft power when the competition runs its course to that point. A strategic mind is needed here on the soft power front.

Finally, how competition between China and the U.S. on these fronts will impact the performance of U.S. capital markets, and what investors (esp. long-term investors) need to do to stay ahead of the curve? Here are some of my predictions:

First, capital markets will become regionalized, with the U.S., Europe and Asia each having their own regional financial centers that will be more independent from one another than they are now. Although globalization as we know it will be significantly curtailed, people will continue to trade. Gold will become more important (again!) as a globally acceptable reserve currency. Bitcoin will come along but remain a distant second. The U.S. dollar will relinquish its global reserve currency role, eventually. RMB will drag its feet to the role of a global reserve currency, if it ever assumes it. Foreign capital that is currently parked in the U.S. markets will move out to their respective regions and back to their home regions, at least partially but meaningfully. Several decades’ global expansion of Wall Street firms has already slowed down and in reverse for many banks, and that trend will continue. As a result, pre-positioning of capital/investments in different regions for future returns can be a smart thing for many (if not all) investors to do, although that comes with higher costs than now.

Secondly, sectors that are important to infrastructure build-out for each regions, such as high-tech (hardware and software), defense, energy, industrials and healthcare will likely outperform other sectors and the overall markets. And this will be the case for all three regions. In addition to the competition in high-tech between China and the U.S., Europe are not only finally waking up to the fact that the U.S. is pulling out but also largely have decided to take real actions to shore up infrastructure (high-tech included) and defense capability build-out, and any sizeable build-out will benefit industrials sector, esp. heavy equipment. Energy is not only an important sector to every region, but also a weapon in inter-regional competitions as well, which likely makes the sector volatile from time to time. Healthcare sector will see more intra-region investment that weathers the global tariff havoc, and it can be a reasonable short-term investment target, esp. for the U.S. markets.

Thirdly, the fixed income markets will become more region-specific, in that each region’s fiscal and monetary policies will impact the region’s own fixed income investments more than other regions’. To be sure, this is not anything that the Wall Street would like to see, and Wall Street bankers will try to influence regional governments (esp. in the U.S.) for certain continuation of the globalization policy set-up. Wall Street may succeed, as it has been shown in the past few days in the U.S. that the Trump administration certainly met its match from the markets. However, populism will be running high in every region and every country, and it seems that Wall Street is in general on the opposite side of populism and isolationism. Where exactly we are going to land is not known to anyone at this stage, and it is every investor’s job to try to see through the murkiness and take careful (but also decisive) actions when needed.