September 15, 2023 | 13:07
The Many Faces of De-Risking
The Many Faces of De-Risking
“De-risking fundamentally means having resilient, effective supply chains and ensuring we cannot be subjected to the coercion of any other country.” — Jake Sullivan, U.S. national security adviser, April 27, 2023
“I believe it is neither viable—nor in Europe’s interest—to decouple from China. This is why we need to focus on de-risk—not decouple.” — Ursula von der Leyen, European Commission president, March 30, 2023
No matter the precise definition of de-risking, there is little doubt that the U.S. and other major economies are actively reconsidering all manner of their relationship with China. And in many cases that means limiting and/or reducing involvement. In turn, China is also working to reduce the tight interdependence with the U.S. and aiming for self-sufficiency in a variety of sectors. But is the disentangling having a macro effect?
The U.S. merchandise trade data certainly make it appear that de-risking is in full flow (Chart 1). The share of U.S. imports from China has been in a veritable freefall in the past five years. After peaking at roughly 22%, the share of imports from China has cascaded to under 15% in the past 12 months, the lowest since early 2006. That’s dropped below Mexico’s share of the U.S. import market for the first time in 20 years, and is now barely above Canada’s share. (Aside: This is the first time on record that Mexico is now the number one source of U.S. imports; it had been mostly Canada, outside of Japan’s reign in the late 1980s, until China took over in 2007.) The descent in China’s share of the U.S. market began in earnest with the trade war in 2018, took a brief detour during the first year of COVID—when electronics were heavily in demand—but has gathered steam in the past year.
Yet, one needs to treat the raw trade data with some skepticism. Part of the share shifts reflect price moves, with Canada’s recent rise flattered by higher commodity prices. More fundamentally, some diversion of China’s products to third countries to avoid U.S. tariffs—perhaps for modest alterations or processing—could help explain the sharp drop. While imports of some products from China have declined notably, others have actually risen sharply—including electronics and laptops. And, Canada’s trade flows show no such sign of a major pullback in buying from China (Chart 2). While there has been a small drop in China’s share in the past year, it’s still about 1 percentage point above pre-pandemic levels, and the steady upward trend of the prior decade has not been broken. More broadly, China’s global share of manufacturing exports is still higher than pre-2020 levels.
A somewhat more compelling example of de-risking can be found in foreign direct investment (FDI) flows. Net new investment into China from abroad has fallen below $70 billion in the past four quarters (to 2023Q2), the lowest tally in almost two decades, and a fraction of 2021’s record inflow (Chart 3)—just before talk of decoupling or de-risking gathered pace. The most recent quarter saw net FDI inflows to China all but dry up; the $4.9 billion inflow was the smallest in 25 years of records. To put some of these figures into perspective, net FDI inflows to Canada, a much smaller economy considered to have weak FDI, have been just over US$50 billion in the past four quarters, and US$8.5 billion in Q2 alone.
On the flip side, there has been no such discernable cooldown in outbound investment flows from China (Chart 4). The Biden Administration is now taking a much closer look at investments from China in sensitive sectors, but this hasn’t had an immediate impact on the broader flows. While down from the extremes in 2016, net foreign direct investment outflows from China have topped $170 billion in the past four quarters. At more than $100 billion above FDI inflows, that economy is now thus in the unusual position of being a source of FDI funds to the rest of the world, after being a recipient for decades (aside from the burst in 2016).
At the same time, China is also still reporting substantial outflows of portfolio investment (Chart 4, again). While not quite at an all-time high, these net purchases of foreign bonds and equities pushed above $170 billion in the past four quarters, roughly matching FDI outflows. However, the focus has clearly not been on buying U.S. assets, and specifically Treasury securities. In fact, after being the number one holder of Treasuries for most of the decade up to 2018, China’s holdings are fading fast (Chart 5). After peaking at US$1.32 trillion in 2013, they have since dropped 36% to $835 billion, well below Japan’s $1.1 trillion and not far above the U.K.’s $660 billion. In the past 18 months alone—again, since de-risking ramped up—China’s holdings are down a hefty $200 billion. At that pace, China will reach its own version of net zero by 2030. Note though that overall foreign holdings of Treasuries have still managed to rise by $146 billion in the past year.
Some of China’s drawdown in Treasury holdings may simply reflect an effort to support a drooping currency. But even the recent weakness in the Chinese yuan may not be quite what it seems. The currency recently softened to around 7.3/US$, a level it hasn’t seen since late 2007 (Chart 6). However, that weakness can be readily put down to the entirely conventional cyclical factors which have seen China’s interest rates trimmed even as the Fed has been aggressively tightening. In fact, the yuan is not at all weak when compared to other major currencies—it remains in the very narrow range of the past seven years against the Canadian dollar, for example. On a trade-weighted basis, the currency is down 4% from a year ago, but is still up almost 7% from pre-COVID levels.
Bottom Line: The clearest evidence of de-risking so far has been in the deep decline in foreign direct investment inflows to China, followed by further sales of U.S. Treasuries by China, and the ongoing slide in China’s U.S. import share. However, most of these trends were either already in place before official de-risking began, or may have happened in any event.