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LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR
MARCH 21, 2018
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We were planning to move on from Trade and Tariffs in this issue of IntelDigest, but the Trump Administration insists on keeping the subject front and center in the news. We wrote last week about the Trade Wars which would be the likely result of Donald Trump’s actions. He is about to take another giant step forward in waging economic warfare with China, which was our largest trade partner in goods (not services) last year.
The China Problem – Redux
We discussed Trump’s focus on China last week. Now, media outlets are reporting that Trump is about to announce new Tariffs, amounting to at least $60 Billion, on Chinese products. This will likely precipitate a Trade War between two of the largest economies on Earth. The package could be applied to more than 100 products, which Trump believes were developed by using trade secrets which China stole from U.S. companies or forced them to hand over in exchange for access to its massive market.
We suggested a Measured Approach in our last issue, which would involve negotiations with the Chinese rather than setting up American consumers and companies for harm incurred in a Trade War. But, Trump made criticism of China a significant part of his presidential campaign, so he is determined to use blunt force in pursuit of his goals.
As reported in The Washington Post,
“This looks much more like a president who is excessively eager to apply tariffs than a well-calculated move to defend American interests,” said Phil Levy, who was a trade adviser to President George W. Bush. “There are real concerns about Chinese behavior on intellectual property, for example, but there are much more effective ways to address them.”
John Frisbie, president of the nonpartisan U.S.-China Business Council, was quoted:
“The U.S.-China Business Council believes that tariffs will do more harm than good in bringing about an improvement in intellectual property protection for American companies in China … Business wants to see solutions to the issues, not just sanctions.”
Economists specializing in China have said that it would be difficult for the Trump Administration to target Chinese companies because many products imported from China are made by multinational companies with supply chains that stretch around the world. Chinese manufacturers might assemble these products or put on the finishing touches, but the country does not export as many products to the United States that are entirely made in China.
According to Nicholas R. Lardy, a senior fellow at the Peterson Institute for International Economics, “So much of what we import from China is produced by multinational companies … Thirty percent are consumer electronics. I’m sure the president doesn’t want to raise the prices of those and send Apple’s stock into the toilet.”
Lardy maintains that it will be easier for China to retaliate. China can zero in on U.S. exports such as soybeans, which are entirely made in the United States. Soybeans are one of the top two goods the United States exports to China, along with aircraft and aircraft parts, according to government data.
Further, American producers would gain little from these actions.
“In the best case, they might reduce imports from China by $30 Billion, but it will have virtually no effect on the U.S. global trade deficit,” Lardy continued. “We’ll just start buying things from the next lowest-cost supplier, such as Bangladesh or Vietnam. It’s not that the $30 Billion will magically be produced in the United States the day after they announce these tariffs.”
According to the U.S.-China Business Council, many U.S. states export goods and services to China, including some swing states in the 2016 election. For example, over the decade ending 2016, Pennsylvania exports of goods to China increased 83%, twice the rate as its exports to the rest of the world. And, Pennsylvania exports of services jumped more than four-fold, which was more than five times the pace of the exports to the rest of the world.
In a survey conducted this week by CNBC.com, the threat of a Trade War is rapidly becoming the top economic fear on Wall Street. Nearly two-thirds of the survey respondents see Trump’s trade policies as negative for overall economic growth and likely to cause job losses in the U.S.
Protectionism tops the list of worries on Wall Street, far outpacing concerns over inflation, terrorism and even Federal Reserve actions.
Again, from CNBC.com:
“The market has shifted from a fear of a monetary policy misstep, tightening too aggressively, to a trade policy mistake, escalating into a trade war with China,” Art Hogan, chief market strategist at B. Riley FBR, wrote in his response to the survey. “The balance of risk for equities has moved from the Fed to the White House.”
Added David Kotok, chairman and chief investment officer of Cumberland Advisors, “One man’s income is another man’s expenses. No one wins a trade war.”
Herbert Hoover – Redux
History seems poised to repeat itself.
History remembers Herbert Hoover as one of the worst American presidents. Like Donald Trump, Hoover was a rich international businessman and a political outsider. He had not held public office before his 1929 inauguration. Like Trump, Hoover faced intense pressure from struggling American workers.
He signed into law the Tariff Act of 1930, commonly referred to as the Smoot-Hawley Tariff, which raised Tariffs on thousands of imported goods to record levels. Smoot-Hawley was followed by retaliatory Tariffs from our many trading partners. When the dust settled, American exports were cut in half, which exacerbated the Great Depression.
Nearly a century later, Donald Trump seems determined to walk down the same path.
Trump had threatened China repeatedly while on the campaign trail. He fired the opening salvo in this Trade War last summer, when the Administration opened an investigation against China using Section 301 of the Trade Act of 1974. This Act predates formation of the World Trade Organization (WTO) Dispute Settlement Body, where WTO member states (including the U.S. and China) can meet to settle trade disputes. Section 301 provides authority to the U.S. Trade Representative to take unilateral action against a trading partner.
According to the Financial Times, under the 301 statute, “which has not been widely used since the 1995 creation of the WTO, the U.S. would in effect act as judge, jury and executioner on any grievance that it identifies.”
The investigation was the start of a major pushback against China. In the last two months, the Trump Administration has announced new Tariffs on solar panels, washing machines, and now steel and aluminum. Although China was not specifically identified as a culprit, China is obviously Trump’s main target.
Mr. Trump is likely embarrassed that, after all of his tough talk against China over the last two years, the Commerce Department recently announced that the U.S. had realized its largest ever trade deficit with China during Trump’s first year in office.
Trump seems to see the trade deficit as some sort of economic “scorecard” between the U.S. and China. And, he is using our record-high deficit as a convenient excuse to escalate the Trade War.
Trade Wars
The response of China will likely start with tit-for-tat Tariffs against American agriculture. China is also capable of employing asymmetric forms of financial warfare, including:
* China is one of the biggest producers of consumer goods for the American market, so prices for consumers would be driven higher
* China is the largest holder of U.S. Treasury Debt, currently holding approximately $1.17 Trillion
* Our Federal deficit is expected to soar over the next few years, so the U.S. Treasury will be issuing lots of new bonds … large foreign buyers of our debt, such as China, will be needed to keep interest rates from soaring
* China could retaliate with their own Tariffs on American manufacturing, agriculture, and high-tech goods, and block U.S. companies from the Chinese market
* China could also threaten to diversify its reserves away from U.S. Treasuries; China has been stockpiling Gold for years, and working toward replacing the U.S. Dollar as the reserve currency for the world
* China could devalue the yuan … when it did so in August and December of 2015, U.S. stocks fell more than 10% on both occasions
We will return to Investing and The Economy next week in IntelDigest. There are several favorable conditions which continue to support the “Melt Up” in the Markets. However, an honest-to-goodness Trade War could be just the thing which would derail our economic engine.