Trade I: US-China Negotiations Underway. Lots of new developments have occurred since the US released its Section 301 report on China’s unfair trade practices on March 22. Melissa and I covered the 215-page report in detail in our 3/26, 3/27, 3/29, and 4/5 Morning Briefings. Previously, we discussed China’s overt strategic plans for global technology dominance through its IDAR approach: introduce, digest, assimilate, and re-innovate.
The US Trade Representative (USTR) paints the IDAR approach as a means for China to steal intellectual property from abroad, asserting that the Chinese government does so by crafting unfair policies. These policies, the USTR argues, create an uneven playing field for foreign entities, which must choose to comply or forgo access to one of the largest markets in the world.
Keeping track of who-said-what-from-where following the release of the USTR’s report is enough to make your head spin. For now, the most important thing to keep in mind is that the latest developments are mostly talk. While both the US and China has threatened significant tariffs on goods imported from the other, neither has taken significant action at this point. The questions are when and where—in terms of tariff levels—will the trade dispute end?
Still, there is plenty of time for negotiation. The US has 180 days following the comment period on the Section 301 report to decide whether it will follow through on the actions proposed. Even if the US or China proceeds with announced retaliatory measures, the measures may not make much of a dent in either economy. In any event, investors need to keep track of what’s been said to assess what might be done in the future. I asked Melissa to keep a timeline of the developments since the release of the USTR’s 3/22 report. Here is the latest:
(1) Tit-for-tat. On April 5, President Trump warned that he might impose $100 billion in tariffs on imports to the US from China. That was incremental to the targeted 25% levies across 1,300 categories of Chinese goods amounting to $50 billion announced on April 3, reported the 4/3 WSJ. In response, China proposed incremental 25% retaliatory duties on up to $50 billion of US goods, including aircraft and soybeans. So far, none of these proposals have been implemented.
Last month, the US imposed a 25% tariff on worldwide imports of steel and a 10% tariff on imported aluminum. Some nations have negotiated temporary exemptions from the aluminum and steel tariffs, but not China. That action has been put into place. In response, on April 1, China announced new tariffs of up to 25% on $3 billion worth of over 128 kinds of US agricultural goods, effective April 2.
(2) Fender-bender. Neither of those tit-for-tat measures initially implemented is expected to make a real dent in either economy, assuming that the tariff spat will be solved amicably, as we expect. For comparison to the $3 billion in Chinese tariffs on agricultural goods, the US exported $140.5 billion of agricultural goods last year, according to the US Department of Agriculture. The US annually sends $14 billion worth of soybeans to China alone.
For a sense of scope on aluminum and steel, only about 2% of US steel exports are sourced from China. More broadly, in 2017 the US ran a $375 billion trade deficit with China, which the President aims to reduce by $100 billion.
For perspective on the GDP impacts of the total potential tariffs imposed, Mike Bell, a global market strategist at JPMorgan Asset Management, figures that “25% of $150 billion is about $37.5 billion. That seems like a large number, but when you put it in perspective, it’s about 0.3% of Chinese GDP. That same $37.5 billion is about 0.2% of US GDP,” reported Business Insider.
Another estimate for the impact on China’s economy was reported by Bloomberg: “A simulation by Oxford Economics suggests a 25 percent U.S. tariff on $60 billion worth of Chinese exports, with comparable retaliation, would reduce China’s growth by about 0.1 percentage point this year and a little less next year, chief Asia economist Louis Kuijs in Hong Kong said in a recent note.”
(3) Deal in the making. As noted above, most of the proposed US-China tariffs have yet to be enacted. On May 15, the USTR will hold a public hearing on the tariffs proposed against China. After that, according to the WSJ, the US has at least 180 days to further contemplate the decision, leaving lots of time for negotiations. On April 6, Larry Kudlow, director of the National Economic Council, confirmed that the US and China were involved in “back channel” negotiations on trade.
On April 21, US Treasury Secretary Steven Mnuchin told reporters at the International Monetary Fund’s spring meeting that a trip to China is “under consideration.” He’s involved in a “dialogue” with the Chinese government over the trade dispute, he said, adding, “We’re cautiously optimistic to see if we can try to reach an agreement.” On April 24, President Trump told reporters: “China’s very serious, and we’re very serious.” The President added: “We’ve got a very good chance at making a deal.”
Up for discussion, according to the 4/3 WSJ, are changes to the existing Chinese 25% tariffs on imported cars, as we discuss below. Also under negotiation is an easing of regulations pertaining to foreign investors in Chinese financial markets, which would create more open Chinese financial markets. Further, the WSJ listed, China will consider buying semiconductors from the US rather than other countries.
Trade II: Dog & Pony Show? So far, there seems to have been at least one substantial outcome of the US-China trade spat: China’s concession to US policymakers to lift ownership rules that limit foreign investment in Chinese carmakers. Is it a YUGE deal? Or just a dog-and-pony show? It may turn out to be the latter. After all, 2018 is the Chinese Year of the Dog. Consider the following:
(1) Concession stand. On April 17, the Chinese government promised to end foreign ownership caps on electric vehicle, shipping, and aircraft manufacturing, reported the FT. Specifically, ownership restrictions currently require 50-50 joint ventures with a Chinese partner in order to manufacture autos on Chinese soil without facing the 25% tariff. That restriction would be eliminated by 2020 for commercial vehicles and for all vehicles by 2022. The rules were originally enacted in the 1990s to help Chinese carmakers to “learn from” (or, depending on your perspective, steal intellectual property from) foreign market leaders.
However, the concession was accompanied by a 178% duty placed on US sorghum crops, a grain used to feed livestock. During 2014, China started buying larger amounts of US sorghum after “inflated grain prices set by Beijing made US imports relatively cheaper.” Last year, China imported almost $1.0 billion of US sorghum. The USTR is reportedly considering taking the sorghum tariffs up with the World Trade Organization.
(2) Symbolic victory. Robert Zoellick, chairman of AllianceBernstein, told the WSJ that even if China were to lower car import tariffs from 25% to closer to the US’s 2.5%, the US victory would be only a symbolic one, because it most likely would help only German car makers that export to China from their plants in the US. That is “because the U.S. producers are Ford and GM, and they’ve got their plants in China, so what difference is it going to make? It would make a difference for BMW, and BMW in South Carolina exporting and so on and so forth,” he said.
(3) Complex gift. A 4/17 WSJ article said it would be costly and complicated for foreign car makers to extricate themselves from any pre-existing Chinese partnerships. “Reaching an agreement on the venture’s valuation would likely be one obstacle. And foreign car companies might not be able to afford to buy out their Chinese partners, said Janet Lewis, Macquarie Capital Research’s managing director of equity research.”
A person familiar with GM’s strategy said the prospect of reaping 100% of the profits may be enticing, “but you’d also get 100% of the cost and complexity.” Partnerships help, according to this person, in terms of “working with regulators, developing a manufacturing footprint and managing supply chains and retail networks.”
(4) Good for China. Michael Laske, president of Austrian powertrain supplier AVL GmbH’s China operations, told the WSJ that the move would be most beneficial for China: “Lifting limits on electric-car makers by the end of this year would encourage foreign investments from Tesla and others, helping China become the world’s factory for electric vehicles.”
Laske further observed that China wouldn’t have lifted the ownership restrictions unless “they felt they were ready to compete.” That jibes with what we’ve previously written about China’s foreign investment catalogue, i.e., the Chinese government lifts investment restrictions on domestic industries when it benefits China to do so.
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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