Merlin Weekly Macro: Cooperate or Confront: that’s the question.

Donald Trump’s efforts to engineer a ceasefire in Gaza have been fulfilled. Whether it heralds the “peace in the Middle East” that he also hopes for is debatable: it is an enduring problem with a century of bad blood of which Gaza is only a part. Mixing pragmatism with optimism, a solution to the conflict in Gaza is a pre-requisite of wider peace even if it does not ordain regional tranquillity, but without the Gazan agreement there would be no possibility at all.

China Crisis

Meanwhile, the UK government, with the spotlight uncomfortably shining on Sir Keir Starmer and his National Security Adviser Jonathan Powell, is rapidly being engulfed in a political row. The subject is our relationship with China. Is China an “enemy” for the purposes of bringing a successful prosecution under the Official Secrets Act 1911? The flashpoint is the collapse of the Crown Prosecution Service case against two UK nationals charged with political espionage, accused of passing sensitive information about policy and politicians to Beijing.  Bear in mind that five current or former Westminster MPs including one-time Conservative leader Iain Duncan-Smith and Tory leadership contender Tom Tugendhat remain personally sanctioned by the Chinese government for expressing views (“misinformation”) that Beijing deems hostile to Chinese security.

Whatever will emerge of who knew what, and who in government said what to whom, and who was the ultimate authority that caused the rug to be pulled (“blindsided” was the term applied by both) from under both the CPS and the Home Office as the case was deliberately collapsed, the incident poses significant questions. Specifically they relate to how other nations are perceived and defined when the potentially conflicting needs of your own national security and diplomacy clash. Distilled down to its most basic, national security is about keeping others out; diplomacy is about drawing them in: what happens when the two are incompatible?

China context

China is the UK’s fifth largest trading partner with aggregated imports and exports totalling £92.6 billion in 2024. It ranks behind UK trade with France, Holland and Germany and is dwarfed by the US at over £300 billion; that said, it is the country with whom we have the largest current account deficit (imports exceeding exports) at £26 billion. China accounts for virtually none of the Foreign Direct Investment into the UK; going the other way, the current “stock” of UK investment projects in China amounts to £8.9 billion, around 0.5% of all UK outward investments.

The current government’s policy towards diplomacy and trade including generating mutual investment opportunities with China is governed by the “Three Cs”: Compete; Challenge; Cooperate. At 18% of global GDP, the world’s second largest economy and five times the size of the UK, China is impossible to ignore. As the principal source of solar panels it is instrumental in the government’s push into renewable energy. China owned a one-third stake in the Hickley Point nuclear power station, though following differences of opinion with the previous Tory administrations (in Teresa May’s first month as Prime Minister, her first public row was with China about who controlled the on/off switch at Hinckley Point) it stopped committing any new investment in December 2023 and the percentage holding has been diluted. As a national security protection promulgated by the Conservatives, Chinese tech giant Huawei is being eased out of the UK’s 5G infrastructure development and will have no involvement beyond 2027.

China challenge

The nub of the issue here is what sort of threat is China to the UK that determines whether it is an enemy or not? Or is it in a grey area? The UK Chiefs of Staff regard Russia as the most significant direct military threat. The intelligence agencies, particularly MI5 (domestic counter-intelligence) and MI6 (The Secret Intelligence Service, overseas intelligence gathering) see China as the greater strategic danger. That is not to say they disagree; it means that both are simultaneously significant threats but of a different nature. The June 2025 Strategic Defence Review describes Russia as “an immediate and pressing threat”; China is couched as “a sophisticated and persistent challenge”.

The reality is that the two are joint and several and becoming increasingly indivisible in thought, word and deed. Witness the very public support from China for Russia in the United Nations since February 2022; the joint communique issued by Moscow and Beijing on May 9^th this year after the VE Day anniversary and their combined views on global stability (bathed deep in cynicism and hypocrisy given Russia invaded Ukraine illegally and China has public intentions of “recovering” Taiwan to the Motherland), and the shared threats they see being posed by NATO; Xi and Putin attending each other’s military parades as a demonstration of mutual strength, strategy, support and friendship. 

Use of the term ’threat’ implies the potential for something yet to happen. In reality the joint threat posed by Russia and China has already crystallized: through destruction of infrastructure assets (e.g. blowing up the Nord Stream 2 gas pipeline; or the destruction of the electricity cable between Finland and Estonia last December); or Russian state-sponsored assassination of nationals living abroad whom it regards as a threat; Russia’s active use of asymmetric forces such as the GRU and Wagner to channel illegal migration into western countries to create societal tensions and government instability; the recent Russian aerial drone and jet-fighter incursions over several western European countries;  or China’s active and orchestrated programme of insinuation and espionage in commerce and particularly western universities (even the Royal Family!). Employing a range of hybrid means including prolific cyber-attacks and interference in elections, both are actively engaged in undermining western interests and political systems including those of the United Kingdom.

US National Security Agency senior adviser Rob Joyce coined the memorable phrase “Russia is the storm; China is climate change”. China’s strategic aim is to lead a new world order (i.e. with China at the apex and everyone else a vassal, subsidiary, subservient or deferential); it is an explicit objective set out in Chinese Communist Party (CCP) literature. The terrestrial One Belt One Road and maritime String of Pearls infrastructure projects are designed to give China global leadership and to confer global strategic patronage on Beijing. The strategy is prosecuted through carefully planned economic support and investment extending not only across Asia and Europe but in Africa and Latin America. It is a well-planned programme of fiscal neo-colonialism which places ‘beneficiaries’ in the debt of the CCP. It is designed to give Beijing control (or at least significant influence) over natural resources, manufacturing, technology, infrastructure, trade routes and supply chains globally. In terms of its land strategy, Iran is key: blocking the entire land mass from the Gulf to the Caspian, Iran’s cooperation determines whether China’s New Silk Road is intercontinental or merely a pan-Asian cul-de-sac. These means of gaining advantage are backed up by significant military expenditure and innovation (as well as being a nuclear power, China now has the world’s biggest navy and is recognised as being a generation ahead of the West in the development and deployment of hypersonic missile technology).

The direct military threat from China currently focuses on Taiwan and the China Sea. Chinese forces are instructed to be prepared to invade Taiwan no later than 2027. The consequences of China gaining control of Taiwan are significant globally: Taiwan accounts for 90% of all semi-conductor manufacturing capacity; were that capacity seized intact, China’s global industrial control would be obvious; were it to be destroyed as a means of Taiwan denying control to China, so ubiquitous is the use of such chips that global manufacturing could potentially quite literally grind to a halt. As well as developing the global String of Pearls, China has been actively appropriating disputed atolls in the South China Sea, including the Spratley Islands, the Paracels and recently, surveying the Scarborough Shoals; applying the adage of occupation being nine tenths of the law, to secure its new ‘possessions’ China quickly develops and militarises such reefs and atolls including equipping them with airfields and missile batteries.

As we have said in previous columns, the risk is growing that a future military conflict would not be with Russia or China, but with both simultaneously.

China conundrum

The UK’s lack of confidence in how to approach China, whether to cooperate with Beijing or confront it, is far from unique. Many EU countries and Brussels itself are happily coat-tailing China hoping for crumbs of economic advantage. For all Trump’s bluster, even the United States is hesitant. Consider the Ukraine war: if Trump were really serious about neutralising Moscow’s ability to wage war, he would be putting an impermeable blockade around Russia. Sales of oil, gas, grain, fertiliser etc would be fully embargoed and impossible. Not just messing about with tariffs, he would be applying full sanctions against any country colluding with Russia in trade and the transfer of technology. That would include China and India (as well as the EU). It is not happening. He is still negotiating with China about tariffs, having extended the original 90-day post-“Liberation Day” pause period to 1^st August by a further 90 days to mid-November; in the escalating tariff war with China in the Spring, as well as nervous bond markets pushing up the cost of US government borrowings he became chary of public opinion about the rapidity with which US-Sino trade dried up, West Coast ports became ghost-town quiet and shop shelves emptied themselves.

If the threat from Russia is overtly offensive by whatever means, that posed by China is more subtle and subversive but no less pernicious and (as assessed by MI6 in a foreign perspective and MI5 domestically, the latter at the heart of the controversial collapsed spying prosecution) at least as dangerous.

At what point are the actions and intentions of such countries so inimical to one’s own interests that a line in the sand needs to be drawn? When do they become an “enemy”? The parallels with the 1930s and the appeasement of what became the Axis Powers (Germany, Italy and Japan) are very real. The current British government has already made a big strategic error of judgement compromising the security of NATO military and intelligence operations in the Indian Ocean based on Diego Garcia by handing over the Chagos Islands to Mauritius, a country closely aligned with China: Beijing pronounced it an “excellent” deal and congratulated the Mauritian government. This week, political suspension of the criminal prosecution of two British nationals accused of espionage on behalf of China will only encourage the Chinese Communist Party and its General Secretary that it can carry on spying in the UK literally with impunity. A simple question: at what point in diplomacy with China do the “Three Cs” become “One C”? Craven.

Jupiter Merlin and China

From an investment perspective, how does the Jupiter Merlin Independent Funds team approach China? It is almost impossible not to have an indirect exposure to companies engaged in trade with China, so embedded is China in global commerce. However, we try as far as possible to eliminate having any direct investment in Chinese companies: we are far less concerned about the return on your capital than we are about the return of your capital. And as a matter of principle we are not minded to help fund a government whose stated ambition is not only to eat our lunch but by 2049 to be our overlord.

The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.