IN 1784 the Empress of China set sail from New York, on the first American trade mission to China. Carrying ginseng, lead and woollen cloth, the merchants aboard dreamed of cracking open the vast Asian market. But the real profit, they found, came on their return, when they brought Chinese teas and porcelain to America. As other ships followed in its wake, the pattern became clear. Americans wanted more from China than Chinese wanted from America, and the difference was made up with a steady outflow of silver from America into China. The Empress had launched not just commercial ties between the two great countries but also an American deficit in its trade with China.

The modern incarnation of this deficit is still driven by the flow of consumer goods, but nowadays electronic gadgets. In recent years it has reached a record size (see chart 1). When Xi Jinping, China’s president, meets Donald Trump—a meeting is reportedly planned in Florida early in April—the deficit will top the agenda. In his run to the White House, Mr Trump promised a combative stance against China on trade. Some expect America to slap punitive tariffs on Chinese goods, triggering an all-out trade war. Others think a grand bargain that defuses tensions is possible.

Many American businesses, bruised in their dealings with China, cautiously welcome a harder line. For their part, Chinese businesses feel unjustly singled out. Both sides are nervous, conscious that the world’s most important economic relationship is also its most complex. America and China are bound together by cross-border flows of goods, cash, people and ideas that are bigger than ever. These ties have greatly benefited the two countries’ prosperity. A rupture would be severely damaging for both.

The original sin, for Mr Trump’s most hawkish advisers, is the trade imbalance. Before China joined the World Trade Organisation (WTO) in 2001, China accounted for less than a quarter of America’s total trade deficit; over the past five years, it has made up two-thirds. Peter Navarro, head of Mr Trump’s new National Trade Council, sees the deficit as a drag on America’s economy. Close it, he argues, and America’s GDP will be bigger. And he sees a way to do so: take on China over its unfair trade practices, from currency meddling to export subsidies. In 2012 he released a documentary, “Death by China”, as a call to arms.

Mr Navarro’s views rely on crude arithmetic that defies the most basic economic logic. In fact, big deficits often accompany fast growth. And it is misleading to focus on bilateral imbalances in an age of global supply chains. Counting the bits and pieces from other countries that go into “made in China” smartphones, fridges and televisions, China’s trade surplus with America is about a third smaller than officially reported.

Yet the gap ought perhaps to be smaller still. American companies insist that, with a level playing field, they would be able to sell much more to China. Some of the obstacles in their way are obvious. Carmakers, for instance, face 25% import tariffs. More often, barriers are subtler. Medical-device makers cite onerous licensing procedures and seed firms lengthy approvals.

Indeed, America had been adopting a firmer approach to China on trade long before the election. Barack Obama’s administration stepped up pressure through the WTO. Of America’s 25 formal WTO complaints filed after 2008, 16 were against China. The administration also initiated 99 anti-dumping and countervailing-duty investigations against China, more than against any other country (see chart 2).

China sees a pattern of unfair treatment. For Mei Xinyu, a researcher at the commerce ministry, what is wrong with the bilateral relationship is obvious: “American protectionism”. America has to cure its own ills and building walls won’t help, he says. Most emblematic is America’s decision to withhold “market-economy status” from China, which allows higher duties to be put on Chinese imports.

Chinese officials cite another example of unequal standards—the time-worn American complaint, made especially loudly by Mr Trump, that China fiddles its currency to cheapen its exports. China certainly does manage the yuan, but over the past decade it has let it appreciate by nearly two-fifths against a broad currency basket—more than any other big economy has.

Left to its own devices, the trade relationship between China and America should become more balanced in time. As China’s middle class grows, its consumers are buying more from abroad. Chinese demand for American agricultural products, especially soyabeans, has boomed. China is already buying more services from America then vice versa. One of America’s biggest exports to China is education. The number of Chinese students in America has reached nearly 330,000—almost a third of all foreign students—and is up more than fivefold over the past decade.

Battle lines

But if Mr Trump carries out his most extreme threats and whacks a 45% across-the-board tariff on Chinese goods, trade flows between the two giants—the world’s biggest bilateral trading relationship—would shrivel. Collateral damage to the global economy would be immense. The very survival of the rules-based international trading system would be at stake.

China would, in a conventional analysis, suffer more in a trade war. About a fifth of its exports go to America, equating to nearly 4% of Chinese GDP. Less than a tenth of American exports go to China, worth less than 1% of American GDP. But a fight would also hit America hard. No other country could easily replace China in making many of the products, from toys to textiles, that fill American shops. Consumers would face sharply higher prices. American companies that have used China as a production base would struggle to reconfigure their supply chains. If American firms brought factories back home, prices would rocket. Goldman Sachs, an investment bank, estimates that the cost of producing clothing would increase by 46% and smartphones by 37%.

Moreover, China would retaliate. Even if America as a whole runs a deficit, it has industries and companies that increasingly rely on Chinese demand. Nearly half its fruit and seed exports go to China. China is in some months the world’s biggest market for iPhones. Semiconductor-makers such as Qualcomm and Broadcom derive most of their revenues from China (see chart 3).

All this helps explain why Mr Trump has so far trod softly in confronting China. James McGregor, Greater China chairman of APCO Worldwide, a lobbying firm, says that American bosses have been streaming into Washington for meetings with the Trump team to appeal for calm and to teach them that “China is not a country to be toyed with.” But perhaps Mr Trump has merely been distracted by the rocky start to his domestic agenda and it is only a matter of time before he lashes out at China. If he does, though, he will soon learn that trade is not the only show in town. Investment gets much less attention but is also vital to the relationship.

Start with a myth—that China can bankrupt the American government. Over the past decade, China has invested more than $1trn in Treasuries. At its peak, America owed more money to China than to anywhere else. Pundits fret that, were China to dump its bonds, American interest rates would shoot up and the dollar plummet.

But that is to misunderstand the financial mechanics. The Federal Reserve has demonstrated that it can buy far more government bonds than any foreign or domestic holder can sell. China thus cannot dictate interest rates in America, much less push it into penury. And the volatility of the dollar is also a Chinese concern. Because Chinese companies borrowed heavily abroad, dollar strength has made their debts more costly in yuan terms.

Financial exposure goes the other way, too. Back in 2015 the Fed was planning to embark on a series of interest-rate increases. In the end it managed to deliver its second rise only at the very end of 2016. Jitters over China’s economy had stayed its hand. American investors have learned that news out of China can wreak havoc on their portfolios. Anxiety about China has triggered two of the three most recent “risk-off” episodes in global markets, as captured by the VIX, a measure of stockmarket volatility, popularly known as the “fear gauge”. This is the crucial point: it is not that China has the financial upper hand over America, or vice versa; it is that they are increasingly joined at the hip.

Mutually assured destruction

And these are just the financial linkages, which remain limited by China’s capital controls. Look at the physical investment ties between China and America and the mutual vulnerabilities are even more glaring. According to official data, roughly 1% of the stock of American direct investment abroad (money spent on assets such as factories, warehouses and shops) is in China. But this misses much of the cash routed through the Cayman Islands or Hong Kong for accounting reasons. An analysis last year by the Rhodium Group, an American research firm, took a granular approach to calculate that the true stock of American foreign direct investment (FDI) in China built up from 1990 to 2015 was $228bn, three times the official figure.

American companies initially lighted on China as a cheap manufacturing base; as costs there have risen, that wave of investment has tailed off. A new influx seeks to tap China’s consumer demand. In 2016 China was the leading emerging market into which American firms poured FDI. China’s booming middle class is forecast by McKinsey, a consultancy, to grow from just 6% of urban households in 2010 to over half of the total by 2020.

For firms that have made it in China, the rewards have been immense. Through joint ventures with local partners, GM sells more cars, and makes more profits, in China than it does anywhere in the world. Over the next two decades, Boeing estimates, China will buy 6,000 new aeroplanes, becoming its first trillion-dollar market. Starbucks is opening new cafés in China at a pace of over one a day. On official estimates, some 1.6m people in China now work for American subsidiaries.

But success stories of American companies in China will not exactly warm the hearts of Mr Trump’s band of economic nationalists. What they want is money invested in America, not more profits made abroad. Forget for a moment that this policy risks doing more harm than good (preventing Apple or GM from going big in China would hurt them financially). The more relevant point—the one likelier to sway Mr Trump—is that the bigger investment flows these days are from China into America.

Chinese investment into America used to be tiny. No longer (see chart 4). Rhodium estimates that it leapt from about $16bn in 2015 to some $46bn in 2016, compared with $13bn invested by American firms in China. Chinese investments are already thought to support roughly 90,000 American jobs across several dozen states. The money is spread across virtually every area of the economy. Chinese companies have bought Hollywood production companies, car-parts- and appliance-makers, semiconductor firms and more.

China is well aware that its investors can also convey a positive message. Witness Jack Ma’s meeting with Mr Trump, just before his inauguration. Mr Ma, founder of Alibaba, a Chinese e-commerce giant, boasted that his shopping portal would create 1m jobs in America, giving small businesses and farmers a platform to export to Asia. The promise was far-fetched (Mr Trump might appreciate that). But there was a kernel of truth: Chinese investors are only getting started in America.

Were it just a question of money, these investment trends ought to be the clincher, giving America and China every reason to stay on each other’s good side. But investment cannot be divorced from power, and that poses complications. Most obvious are national-security concerns. Both China and America have become more active in restricting each other’s technology and blocking deals that they fear might compromise their security.

But commercial competition casts an even bigger shadow. China and America are increasingly butting heads. “Made in China 2025”, an industrial plan unveiled in 2015, is indicative of how China is gunning for industries that America and other foreign countries have dominated. China aims to become a leader in ten strategic sectors, ranging from next-generation IT to agricultural machinery.

Critics in America warn that China’s state-driven model for advancing in these industries will cause damage around the world. Their worry is that China will deploy much the same industrial policy that it has used in sectors from wind power to high-speed rail: pressure on foreign firms to share technology; protection of local firms; targets to phase out imports; and generous state funding. “This could lead not only to China taking over market share but, because of its scale, destroying entire business models,” says Scott Kennedy of the Centre for Strategic and International Studies, a think-tank in Washington, DC.

Another casus belli

How America might respond to this perceived threat remains hazy. A committee recommended to Congress last year a ban on all investment in America by China’s state-owned enterprises (SOEs)—a measure as likely to lead to a full-blown trade war as Mr Trump’s 45% tariff wall. A recent review of the semiconductor industry called for a stiffer response to China’s market distortions. Others argue that fears of “Made in China 2025” are overblown. Government interventions may work in industries such as solar power and railways, which are dominated by subsidies and public-sector procurement. But they have already been seen to fail in consumer industries such as carmaking.

China’s government has tried to rebut critics of its industrial plan. The point, it says, is merely to give companies guidance about future trends. Meanwhile, Chinese firms, for their part, fear that obstacles in America are proliferating. He Fan, a prominent Chinese economist, says the feeling is that business in America is becoming more politicised. “You can only have long-term investment when the rules are clear,” he says. “Previously that was America’s strong point. Now it’s uncertain.”

It’s alright, Ma, I’m only squeezing

Easily lost amid the blaze of recriminations is the extent to which competition between China and America can also yield benefits. The two countries are already spurring each other to innovate. American venture capitalists are well embedded in the software cluster in Beijing and the hardware ecosystem in Shenzhen, a city in southern China. American private-equity firms are prominent in China, making bets on industries ranging from health care to energy. American multinationals used to build shiny R&D centres in Shanghai and Beijing to please officials, but did little original work in them. Now, firms ranging from industrial conglomerates like GE to biotech giants such as Amgen are doing some of their cutting-edge research in China.

China’s most inventive firms are also investing heavily in America in search of talent and new patents. Just this week, Tencent, a tech giant, said it was spending $1.8bn to buy 5% of Tesla, a maker of electric cars. Huawei, Alibaba and Baidu are its near-neighbours in Silicon Valley. BGI, the world’s biggest genome-sequencing firm, is opening a laboratory in Seattle to be closer to the Gates foundation, a big client. Mindray, a medical-devices firm, has a couple of American R&D labs. Lenovo, the world’s biggest maker of personal computers, is inventing and manufacturing B2B products in North Carolina.

One possibility is that, as these kinds of cross-border business operations become more widespread, the Chinese-American economic relationship will settle down. Competition will be welcomed as healthy, not feared as destructive. But it is likely to be a long time before that happens. It would help if the governments could see eye to eye—in particular, if they could agree on a long-stalled bilateral investment treaty; and if they could reach an understanding on trade before their disagreements threaten the WTO itself.

Both outcomes, however, are highly unlikely. The diplomacy needed to navigate the shoals of their economic ties is in short supply. China’s success in low-end manufacturing has already caused a backlash in America. As Chinese firms take on companies at the heart of the American economy, the friction will surely increase. It is enough to make one nostalgic for the days when their business involved little more than swapping silver for silk.