Wall Street caught between a rock and a hard place as tensions between US and China rise

The trade war between China and the US has spiralled into unchartered territory. On April 10, the Trump administration imposed a tariff of 125% on all Chinese imports. China called the actions unfair and responded with similar measures.

Within the broader debate around unravelling economic ties between the US and China, where economic interdependence has increasingly been viewed as a threat to US national security, this escalation raises questions about whether global finance is also reducing its presence in China.

After all, the risks of financial connectivity with China have been discussed prominently by US policymakers in recent years. And many financial analysts have spent much of the past year discussing whether China has become “uninvestable” due to rising geopolitical tensions.

However, as I show in a recently published study, most global financial firms have continued to expand their presence in Chinese markets over the last decade, even as tensions have intensified.

Crucially, they have done so on China’s terms, operating within a system that prioritises government oversight and policy goals over liberal market norms. This pragmatic accommodation is quietly reshaping the global financial order.

China’s capital markets, which have historically been sealed off from the rest of the world, have been opening up in recent decades. This has prompted global financial firms to expand their footprint in China.

Investment banks such as Goldman Sachs and JP Morgan have taken full ownership of local joint ventures. And asset managers like BlackRock or Invesco have established fund management operations on the Chinese mainland.

Yet China has not liberalised in the way many in the west expected. Rather than conforming to global norms of open, lightly regulated markets, China’s financial system remains largely guided by the state.

Markets there operate within a framework shaped by the policy priorities of the central government, capital controls remain in place, and foreign firms are expected to play by a different set of rules than they would in New York or London.

Foreign investors have been allowed to buy into mainland markets, but through infrastructure that limits capital outflows and preserves regulatory oversight.

Rather than adapting China to the global financial order, Wall Street has accommodated China’s distinct model. The motivation behind this is clear: China is simply too big to ignore.

Take China’s pension system as an example. Whereas pension assets in the US amount to 136.2% of GDP in 2019, in China these only amounted to 1.6%. The growth potential in this market is enormous, representing a trillion-dollar opportunity for global firms.

Consequently, index providers such as MSCI, FTSE Russell, and S&P Dow Jones – key gatekeepers of global investment – have included Chinese stocks and bonds in major benchmark indices.

These decisions, taken between 2017 and 2020, effectively declared Chinese markets “investment grade” for institutional investors around the world. This has helped legitimise China’s market model within the architecture of global finance.

America strikes back

In recent years, Washington has sought to curtail US financial exposure to China through a growing set of measures. These include investment restrictions, entity blacklists, and forced delisting for Chinese firms on US stock exchanges. Such actions signal a broader effort to use finance as a tool of strategic leverage.

The moves have had some effect. Some US institutional investors and pension funds have declared China “uninvestable”, and are reducing their exposure. American investments in China have roughly halved since their US$1.4 trillion (£1.1 trillion) peak in 2020.

But attributing this solely to geopolitical pressure overlooks another key factor: China’s underwhelming market performance. A protracted property crisis, a government crackdown on tech companies, and a weak post-pandemic economic recovery have made Chinese markets less attractive to investors in purely financial terms.

More strategically oriented investors from Asia, Europe and the Middle East have invested more into Chinese markets, filling gaps left by US investors. Sovereign wealth funds from the Middle East, especially, have engaged in more long-term investments as part of broader efforts to strengthen economic cooperation with China.

And at the same time, many western financial firms have doubled down on their presence in China, expanding their onshore footprint. Since 2020, institutions like JP Morgan, Goldman Sachs and BlackRock have opened new offices, increased their staff, acquired new licences and bought out their joint venture partners to operate independently as investment banks, asset managers or futures brokers.

It has become more difficult to invest foreign capital in China. But western financial firms are positioning themselves to tap into China’s huge domestic capital pools and capture its long-term growth opportunities – even as they tread carefully around geopolitical sensitivities.

Fragmenting financial order

It is too early to predict the long-term effects of the current geopolitical tensions. But Wall Street is trying to placate both sides. On the one hand, it is adapting to capital markets with Chinese characteristics. And on the other, it is trying not to antagonise an increasingly interventionist America.

However, while holding its breath amid further escalation and having scaled back some of its activities, Wall Street has not left China. It is instead learning how to work within the constraints of a system shaped by a different set of priorities.

This does not necessarily signal a new global consensus. But it does suggest that the liberal financial order, once defined by Anglo-American norms, is becoming more pluralistic. China’s rise is showing that alternative models – where the state retains a strong hand in markets – can coexist with, and even shape, global finance.

As tensions between the US and China continue to rise, financial firms are learning to navigate a world in which existing relationships between states and markets are being reconfigured. This process may well define the future of global finance.