China Tensions Are Rising

On Nov. 8, two days after the U.S. presidential election, the People’s Republic of China will convene its 18th National Congress, thus transferring leadership of the government for only the fourth time since 1949. (I wrote a column in April about what investors should watch for over the next six months in China.)

In this environment, the trade and political relationship between the U.S. and China has begun to show signs of deterioration that are not simply the result of economic malaise in either country or their politics. Although there are multiple issues at play, the most fundamental continues to be access to oil for each country. One energy issue that repeatedly recurs in the financial media and among politicians is the topic of peak oil. The currently dominant theme or meme is that peak oil is now irrelevant (whether or not it is real) because the natural gas reserves that have been discovered in many parts of the world afford a global conversion to natural gas as an oil substitute, if necessary.

This may or may not be true. In either case, however, in the immediate, the rate of increase in demand for oil in China and the U.S. is still greater than the ability of oil producers to meet. Any conversion to natural gas as a substitute will take years, perhaps a generation or longer, to complete. As such, it is of little immediate relevance.

But the competition for access to oil between China and the U.S. is an immediate concern, not only for the relationship between the two governments, but also for everyone else in the world needing oil. One of the benefits of the current geosynchronous economic slowdown is that increases in demand for oil have waned as a result. This has helped to decrease political tensions between China and the U.S. over oil access.

But during the second presidential debate, Mitt Romney reiterated that, if elected, he would declare China a “currency manipulator” and impose tariffs on goods imported from there. This isn’t just election rhetoric, and it should be taken seriously. Naming China as a currency manipulator and imposing tariffs is a convenient way of decreasing the attractiveness of China as a manufacturing center for investors, causing China’s consumption of oil to decrease as those investors look elsewhere to base their operations. China’s leaders are aware, and they may respond by increasing the makeup of the Politburo to be more inclusive of leaders of the People’s Liberation Army.

The issue concerning access to oil between both countries is going to escalate and accelerate from here and be masked by ancillary issues like currency manipulation, regardless of who wins the U.S. presidential election or what the structure of the Chinese government will be (which we won’t know fully until six months later). As tensions rise, it is logical that foreign investment in China will continue to slow and those already there will increase the rate of withdrawal from the country.

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