Shortly after the geopolitical tension eased off in the Korea peninsula, US-China trade tension intensified. Gary Cohn’s resignation and North Korea’s intention to denuclearize hit the newswire on the exact same date, 6 March. This is no coincidence. Trump said it himself “I have been soft on China because the only thing more important to me than trade is war.” After we understand what triggers the current trade tension between the US and China, let’s take a closer look at the tension itself. I will only highlight two points, as this topic is too complicated to be covered in its entirety in this blog.
It’s not about the trade deficit
In 2017, the US trade deficit with China was about $375bn, representing 47% of the total US trade deficit, with $506bn imports from China and $130bn exports to China. The main contributors of the trade imbalance are, as the chart below shows, cell phones and computers (HTS 8517 and 8471). The US Trade Representative (USTR) Section 301 investigates technology transfer which is what China pursues in their “Made in China 2025” strategy, but the USTR proposed tariff list includes only six products related to HTS 8517 and 8471 with $1.7bn worth of imports in 2017 – the total tariff list amounted to $50bn and includes mainly metal products (iron, steel and aluminum), turbines and engines, transportation (aircraft, automobile and vessels), white goods and electrical appliances, machinery (quite a wide range), and technological products (batteries). We do not expect the proposed tariff list to have a material impact on the trade deficit, and the consensus view is that the impact of tariffs on the economic growth should be relatively small at 0.1-0.3% of China’s GDP. However, we worry that China’s reaction to a reciprocal levy on exports to China, including soybeans, is stronger than our expectations, and the risk of a trade war is escalating. We may have more concrete views as China releases additional details about their tariff. We also note that the current trade tensions can affect other countries in two ways: (1) some countries, such as Korea and Taiwan, contribute to the value-add of the products involved in the tariffs, and (2) there are further on-going trade negotiations between the US and other countries.
It’s about politics
The question investors should be asking is what is in the price and what is not. Our answer to this question is that current market prices have priced in more risk than before. While we are waiting for the proposed tariff list under the Section 301 investigation to go through the public hearing in May 2018, China and the US have started to negotiate on bilateral trade, particularly on semiconductors and agricultural products. This trade overhang should gradually fade one way or the other – with or without a trade war. We believe the best scenario for Trump is a fulfillment of electoral campaign promises without a meaningful retaliation from China, particularly from the perspective of the Republican voters (e.g. soybeans and grains). The best case for Chinese President Xi Jinping is stability in the domestic economy with an uplift of the international and domestic perception of a strong nation (e.g. Xi-Kim handshake). We think the common ground of these two scenarios is relatively broad and there remains a chance for us to get there. A caveat is that views on this trade tension are more like a gut-feel at the end of the day, and how the trade tension unfolds largely depends on the negotiation process. We need to go back to the 80s for Japan-US trade tension, for there are very few similar events in recent history, as history hardly repeats itself in the exact manner. As the trade tension unfolds, we believe market prices are likely to be volatile which could entail temporary mispricing of fundamentals.
US-China trade by products
Source: International Trade Centre, www.trademap.org
1. North Korea Signals Willingness to ‘Denuclearize,’ South Says, The New York Times, 6 March 2018 (link: https://www.nytimes.com/2018/03/06/world/asia/north-korea-south-nuclear-weapons.html)
2. Gary Cohn Says He Will Resign as Trump’s Top Economic Adviser, The New York Times, 6 March 2018 (link: https://www.nytimes.com/2018/03/06/us/politics/gary-cohn-resigns.html)
3. Interview with The New York Times, The New York Times, 28 Dec 2017 (link: https://www.nytimes.com/2017/12/28/us/politics/trump-interview-excerpts.html)
4. Top trading partners, US Census Bureau (link: https://www.census.gov/foreign-trade/statistics/highlights/top/top1712yr.html)
5. Section 301 Investigations, US Trade Representative (link: https://ustr.gov/issue-areas/enforcement/section-301-investigations)
6. Made in China 2025, The State Council of The People’s Republic of China (link: http://english.gov.cn/2016special/madeinchina2025/)
7. Proposed tariff list on Chinese products, US Trade Representative (link: https://ustr.gov/sites/default/files/files/Press/Releases/301FRN.pdf)
8. In a U.S.-China trade war, Trump voters likely get hurt the most, The Washington Post, 22 March 2018 (link: https://www.washingtonpost.com/news/wonk/wp/2018/03/22/in-a-u-s-china-trade-war-trump-voters-likely-get-hurt-the-most)
9. When Xi Met Kim: How China and North Korea Depicted It, The New York Times, 28 March 2018 (link: https://www.nytimes.com/2018/03/28/world/asia/xi-jinping-kim-jong-un-meeting-.html)