President Donald Trump's summit with Chinese leader Xi Jinping puts a spotlight on the precarious U.S.-China relationship and how the two countries are grappling with matters from artificial intelligence to national security. With technology and geopolitics rapidly evolving, it might seem difficult to envision how either of the competing nations might gain the upper hand.
Nonetheless, argues Gavekal Research CEO Louis-Vincent Gave, some clarity can be gained by examining the financial burden each country faces for four essential areas: capital, labor, energy, and government. By Gave's math, most of these have shifted in China's favor, but that doesn't mean investors have to count out the U.S. just yet.
AI remains the biggest question mark-and a double-edged sword.
The cost of capital is likely the easiest to calculate, by looking at short- and longer-term interest rates and each country's respective yield curve. Gave estimates that the cost of capital in the U.S. is currently between 350 basis points and 400 basis points more than in China.
The cost of labor can be somewhat trickier to quantify, as minimum or average wages have to be squared with productivity. Yet China still comes out ahead here, Gave writes, as it has one of the lowest costs of labor in the world-which helps to explain its big annual trade surplus.
The cost of energy is another area where China slightly edges ahead of the U.S. Gave estimates that China has some of the lowest electricity costs in the world for businesses, but the shale revolution dramatically lowered the cost of natural gas and has consequently brought America's energy costs much closer to China's.
"Back in 2011, the U.S. had the cheapest cost of energy, the cheapest cost of capital, very cheap labor (as the U.S. dollar was undervalued following the mortgage bust) and an undervalued currency to boot," Gave writes. "Fast forward to today and China has the lowest cost of capital in the world, a very low cost of electricity, and the lowest cost of labor. And just as with the U.S. dollar in 2011, the renminbi today feels seriously undervalued. So why isn't the Chinese economy growing gangbusters?"
The answer is the fourth and final factor: the cost of government. It's probably the hardest of the four factors to calculate, but for businesses and entrepreneurs, the value of regulation and policy predictability is hard to overstate. One might plausibly argue that the U.S. has struggled with this point during the second Trump Administration, given its trade policies and its speech and actions with regard to Greenland, Venezuela, and Iran, alongside domestic upheaval over a wide range of issues.
However, China scores even lower in this area. Even putting aside the impact of the trade wars with the U.S., its own internal directives have been harmful, from when the "Chinese government pulled the rug from under the feet of a roaring bull market in equities" in 2015 to its directive a few years later mandating domestic banks to stop funding real estate developers, Gave notes.
He also doesn't see much changing in China's favor for a couple of reasons: An improvement in U.S.-China relations seems unlikely and potentially temporary, and consumer-boosting policies are difficult to implement.
As for the U.S., it no longer has many of the tailwinds it enjoyed 15 years ago that best support multiple expansion for U.S. stocks. Instead, the current conditions mean that "a bull market will almost entirely depend on earnings growth rather than multiple expansion," Gave writes.
That's a common opinion, given that the S&P 500 trades near record multiples, and double-digit earnings growth has supported the index as it trades a little more than 1% below its all-time closing high.
Yet Gave closes with a warning that AI remains a wild card. Its failure would mean a higher cost of labor, but its success will cause energy and capital prices to rise. Either scenario could produce the biggest bogeyman for business: policy uncertainty.
Perhaps no AI model can reassure investors that that won't happen.