Proposals to impose tariffs on China and counterproposals by China to hike tariffs on U.S. products are mostly in the bluster and public rhetoric stage. Each side is playing to its own audience while trying to send messages to the other side. A full-fledged trade war isn’t desired by either side, although you would fail to understand this if you get your information from the media, which is having a field day. The U.S. should try to alter China’s many unfair trade policies, which are designed to bolster its domestic firms, especially in high tech areas, at the expense of U.S. firms in particular. This won’t be easy, hence the heavy duty rhetoric. But both sides are being very careful to prevent the situation from deteriorating into a mutually self-defeating trade conflict.
China runs a vast trade surplus with the U.S., exceeding $375 billion in 2017, which makes great headlines. We import almost $4 of goods for each dollar of goods we export to China. The unevenness of trade can be seen in that our threatened tariffs cover 9% of China’s exports here, but to match the dollar value of our tariffs, China’s proposed tariffs covered 38% of our exports to them. Yet, these exports account for only 0.25% of U.S. GDP, which amounts to a rounding error. Total U.S. exports to China are around 0.75%. In contrast, China ships more than $600 billion in goods to us annually, representing more than 5% of its GDP. China’s lift out of poverty was largely driven by its shipments to the U.S. and the rest of the world, which enabled its industrial sector to develop and hire vast numbers of people. Clearly, that’s good for China, but it’s actually also good for the U.S., since it provides domestic consumers with low cost goods and it makes China more inclined to act peacefully. They now have much to lose in any conflict.
The media trumpets the trade conflict and embellishes it with unlikely consequences. For example, Chinese trade surpluses do help finance the U.S. federal deficit since those surpluses fund purchases of U.S. Treasury debt. Some have suggested the Chinese could stop buying, or could sell existing holdings, to drive up U.S. interest rates. But if the Chinese did this, it would also drive down the dollar and drive up the Chinese yuan, undermining China’s trade competitiveness in global markets, which would reduce its surplus over time. Those are undesirable outcomes from China’s perspective. Instead, China proposed imposing tariffs on more than $12 billion in U.S. soybean exports, but China needs to feed its livestock. Such a tariff would mostly shift trade flows around. Brazil might export more soybeans to China instead of to Europe, and we would sell more soybeans to Europe instead of to China. In both cases, importers would likely face slightly higher shipping costs. China’s retaliation might suggest high resolve on its part and might spook American farmers, but it would be far less consequential for either economy than the media would have you believe. In the end, this tariff won’t amount to a hill of beans (pun intended).
The threat of U.S. tariffs is an effort to change long-standing Chinese regulatory requirements on foreign companies that skew trade in China’s favor. One of the more egregious examples applies when a U.S. firm opens a plant in China. It must have a Chinese partner with a 51% interest and must make the underlying technology available to the Chinese partner. In effect, China demands that foreign companies educate Chinese companies to compete with those very same foreign companies, a subject that my colleague, JoAnne Feeney, discussed in a recent Commentary in more detail. As she noted, that’s a very steep price to pay for access to the Chinese market and justifies considerable pressure by the U.S. government to induce China into altering its trade policies. Most critically, we hope this issue isn’t overlooked if China simply agrees to buy more stuff from the U.S. and refrains from changing its policies on U.S. plant investment there.
This effort to force China into changing its trade policies is being played out in the media, almost certainly not the place for it to happen given how bad it would look for China’s leaders if China knuckles under to foreign pressure. So the public political posturing there and here will be intense, even as the conversation happening behind closed doors may lead to a compromise. It is in neither country’s interest for this battle to lead to a full blown trade conflict. That could still happen, even if only as part of the negotiation. But more likely, the trade issue will be resolved with some quieter compromise, even if the politicians claim otherwise publicly.
Equity investors seemed to have figured out that a food fight over trade was not overly likely, but fled in panic at the notion of Trump targeting another $100 billion in Chinese exports. China is likely to retaliate, but its precarious position may quickly become obvious when it runs out of U.S. exports to sanction. China simply has less room to play tit for tat. In the meantime, the U.S. economy continues to plow ahead. March hiring was lower than expected, but still solid. Q1 corporate earnings will start coming out over the next few days and should look very good. So, we remain fairly bullish on the prospects for U.S. equities.