Trade tensions between the U.S. and China have been building over the course of 2018. These tensions have escalated over the last month. But while risks are rising, economic disruptions have remained minimal. We continue to believe the final impact of current trade tensions will not be significant relative to the short to the intermediate term positive impact of
When reviewing the status of trade negotiations with China, it is important to keep in mind what has been put into place and what can still be negotiated. The tit-for-tat threats and counterthreats seen over the last few months may be more aptly viewed as the two countries feeling each other out to better understand the other’s pain points as they (hopefully) progress toward a mutually beneficial relationship as major trading partners. To date, we have seen key tariffs put into place on only washing machines, solar panels, steel, and aluminum. The next stage of tariffs – 25% tariffs on $34 billion (out of $50 billion) of Chinese imports – goes into effect July 6. While there may be more, we typically see about 60 days from announcement to imposition of tariffs to give businesses and trade authorities time to react, which also leaves time for negotiation. The Trump administration’s recent request to draw up a list of an additional $200 billion of Chinese goods for 10% tariffs remains in its early stages and currently can be considered a legitimate threat, but one that is still far from implementation.
ADVANTAGE U.S.
- Goods Surplus – With far fewer goods exported to China than imported from China, the U.S. retains a structural advantage in its trade disputes with China. Last year the U.S. exported $130 billion in goods to China, while China exported $505 billion in goods to the U.S. Consequently, China is going to run out of direct reprisals quickly should it look to match U.S. tariffs, a point brought home sharply by the Trump administration’s announcement that it is looking at potential tariffs on an additional $200 billion in goods, an amount China cannot directly match.
- Moral High Ground – The U.S. has plenty of legitimate moral high ground when it comes to complaints about China’s unfair trade practices, including weak protection of intellectual property rights, excessively restrictive rules for foreign investment, and inadequate protection against industrial espionage. According to the Organization for Economic Cooperation and Development’s measure of investment restrictiveness, China is the most restrictive of any major economy. In addition, a 2011 report by the U.S International Trade Commission that intellectual property-intensive U.S. firms lost approximately $50 billion in profits due to inadequate protection of intellectual property, similar to the number arrived at by the Trump administration’s recent study that led to the initial $50 billion in tariffs. The U.S Chamber of Commerce’s Global Innovation Policy Center also notes in its 2018 rankings of intellectual property rights that the level of infringement in China remains high.
- Strong Political Base – President Trump’s political base may have a high pain tolerance if it believes in the president’s goals, potentially limiting the impact of China focusing its tariffs on politically sensitive areas.
- Credible Threats – Finally, President Trump’s aggressive trade stance makes threats credible that might be otherwise dismissed as unlikely, solidifying his bargaining position.
ADVANTAGE CHINA
- Minimal Political Pressure – China’s President Xi doesn’t have to face reelection and U.S. midterms are around the corner, making the political pain of an extended trade dispute potentially higher in the U.S.
- More Pressure Points Than Just Tariffs – China has many ways to push back on U.S. tariffs outside of corresponding tariffs on goods. For example, informal state-directed consumer boycotts were very effective in a trade dispute with Korea, and U.S. business interests in China are estimated to be roughly in line with China’s $500 billion of goods exports to the United States. A cup of coffee at Starbucks is not an
export , but a boycott of Starbucks would certainly still hurt the bottom line of that U.S. business. China could even make access to its 1.4 billion consumers and more than 6% gross domestic product growth even more restrictive. - Multi-Front Trade Disputes – Despite a shared interest among the U.S. and its allies in reforming China’s international trade relations, simultaneous trade disputes or renegotiations between the U.S. and its major trading partners may limit the pressure other trading partners put on China as they look after their own interest while potentially benefitting from Chinese pressure on the U.S.
- Consumer Price Sensitivity – Consumer prices are likely more sensitive to Chinese exports to the U.S., which have a greater proportion of consumer end products, than U.S. exports to China, which have more intermediate goods.
The Treasury Option – Dumping some of its vast holdings of Treasuries has been called China’s “nuclear option” and would likely cause too much pain to China to be attractive. However, China also has the option of reducing purchases of Treasuries or even using targeted disruptive selling as midterm elections approach. In fact, China could have an impact on Treasury markets simply by floating the idea that it was considering such an approach.
As trade tensions with China rise, it is important to remember that this is still a slow-moving negotiation and that at least some concessions from China were likely from the start. China was already on the path to needed trade reforms as it tried to improve its profile on the world economic stage. While pundits can debate whether the Trump administration’s plan for accelerating reforms is the most efficient, it certainly was necessary. We have yet to see the final cost of likely measures, and both sides can cause more pain. Nevertheless, despite rising concern and heavy market and media attention, any impact thus far has been minimal. While we do expect trade disputes to take a small bite out of the impact of financial stimulus, likely 0.1-0.2% of GDP, and anecdotal reports of business delaying investment pending outcomes are already appearing, we expect the impact of fiscal stimulus to be the primary driver of the U.S. economy over the next year or more.
The views expressed are provided for information only and are not to be used or considered as an offer or solicitation to buy or sell securities or investment products. To determine which investment(s) may be appropriate for you consult your financial advisor.
- The economic forecast set forth in this presentation may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.
- Investing in foreign securities involves special additional risks. These risks include but are not limited to currency risk, geopolitical risk, and risk associated with varying accounting standards.
- Data provided by LPL Financial.
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