Financial Decoupling: What Are We Really Talking About?

In the context of US-China tensions, recent media reports have flagged the possibility of new regulatory or legislative interventions into bilateral financial flows. White House policy discussions are at a more primitive stage than concerns suggest, and the probability of action in this area remains low for the moment. The political discussion – such as it is — inside and outside the Administration has evolved without careful attention to the actual nature and magnitude of the flows underlying the bilateral financial relationship. In this note we inventory the stock of this activity, map political trends that could affect each channel, and consider the price tag and potential implications of government intervention to disrupt financial markets. Our findings are:

Bilateral flows are already sizable in both directions, and the commercial costs of reducing them would be significant, primarily for US financial institutions that seek to manage assets resulting from future diversification of China’s household and corporate savings. An inclusive estimate of assets currently deployed in the bilateral financial relationship points to as much as $3.9 trillion.

Most Chinese firms seeking financing within US markets have other options as well. Restrictions are unlikely to be a meaningful constraint on Chinese firms’ access to finance, particularly for larger state-owned firms.

However, the mere discussion of interrupting bilateral flows may reduce foreign portfolio inflows into China’s equity and fixed income markets, by raising the perceived political costs of these investments. The run-on effect of this could include China’s exchange rate weakening and increased imbalances in bilateral trade flows, outcomes that will worsen should policy discussion of bilateral financial restrictions intensify.

Posted October 9, 2019
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